I-bond fixed rate may sink
By Laura Bruce • Bankrate.com

The May 1 I-bond rate could look mighty attractive if it rises to 5 percent or higher, thanks to inflation. But a nasty cut in the fixed-rate component could make it a lousy long-term investment.

The I-bond is one of the inflation-fighting investments offered by the Treasury Department. Savings bond expert Dan Pederson says he expects the new I-bond's variable rate component -- the one pegged to inflation and adjusted every six months -- to be set at 4.88 percent; up from the current 3.06 percent. On the downside, Pederson, author of "Savings Bonds: When to Hold, When to Fold and Everything In-Between," says the fixed-rate component, which stays with the bond for its 30-year life, could slip considerably, perhaps to 0.5 percent. Nevertheless, those numbers would combine for a new composite yield of approximately 5.38 percent.

But here's the catch. The current I-bond carries a fixed-rate of 1.2 percent. If you buy before the May 1 change you'll get the current composite yield of 4.28 percent* for six months from date of purchase. For the second six months you'll get 6.08 percent, providing the variable rate rises to Pederson's prediction of 4.88 percent. When you buy an I-bond, the earnings rate changes every six months after its issue date. Buy the bond in April, and when October rolls around you'll get whatever variable rate is current plus the fixed rate issued at purchase.

Buy before May 1
"My recommendation is if you're interested in the I-bond, definitely buy before May 1," says Pederson. "I think there's a very great likelihood that the government will trim that fixed rate for new purchases. There's just no need for them to overpay. They could trim it back to 0.5 percent and still have a rate of 5.4 percent. That would still kill most conservative investments. There's no incentive whatsoever for them to increase the fixed rate, there's virtually no incentive for them to keep it the same, but there's a huge incentive for them to trim it."

Pederson notes that the lowest the fixed rate has ever been on the I-bond is 1 percent.

If you're thinking of buying the I-bond for the high yields and then selling as easing inflation lowers the variable rate, keep in mind that you must hold the I-bond for 12 months, and if you sell in less than five years, you'll forfeit three months' interest.

Buy now and you'll get 4.28 percent for the first six months. If Pederson's estimates are correct and you get 6.08 percent for the second six months, you'd end up with an annual yield of approximately 3.88 percent after the penalty if you decide to sell after 12 months. Compare that with the average yield of 1.92 percent on a one-year CD, according to Bankrate surveys, or to the possible 4 percent you could earn on a high-yield CD. You'll have to do some math to see if a savings bond, which is exempt from state and local tax, is a better deal than a CD.

Pederson points out that people who bought I-bonds between September 1998 and October 2001, when fixed rates ranged between 3 percent and 3.6 percent, will see hefty returns on their bonds in the coming months.

"As they enter the next six-month cycle on their particular bond -- and it can be different for every bond depending on when it was purchased -- they're going to see their bonds at somewhere between 7.88 percent and 8.48 percent."

The Series EE Savings bond will also have a new rate announced May 1. Pederson is expecting it to remain right about where it is, at 3 percent.

Keep in mind that the Treasury has severely trimmed the maximum savings bond purchase allowed per individual and per calendar year from the previous $30,000 in paper bonds and $30,000 purchased electronically through www.TreasuryDirect.gov to $5,000 in paper and $5,000 electronically.

Historical I-bond rates

If you'd like to see what your savings bond is worth, try the government's calculator.

*The announced fixed and inflation components don't quite add up to the composite rate because of the way the composite is calculated.