Savings Bonds Stop Paying

'I Bond' Payments Get Wiped Out - When Inflation Goes Negative, Investors in These Savings Products Suffer

Wall Street Journal, May 2, 2009

Rates on government securities, certificates of deposit and savings accounts all have plummeted in recent months. Now, yields on another safe haven -- Series I Savings Bonds, or I bonds -- are dropping to nothing.

Friday, the Treasury Department said these inflation-linked bonds that are purchased between May and October will earn 0% for their first six months, the first time rates have hit 0% since the bonds were issued in 1998. The announcement also affects current I-bond owners, whose interest rate drops to 0% the next time their rates reset.

Blame the financial crisis. Normally, yields on inflation-linked investments gradually rise as prices rise. But amid the sharp drop in consumer-price inflation last fall, returns on many inflation-linked products were hammered.

Rates on I bonds, whose maturities are all 30 years, have two parts: a fixed rate, now set by the Treasury at 0.10% for new issues and which lasts for the bond's life, and the inflation adjustment, which reflects the change in the Consumer Price Index over a six-month period. Since that inflation adjustment worked out to a negative 5.56% annualized rate for the September-to-March period, the fixed-rate portion of every I bond will be wiped out during its next six-month rate period. The Treasury announces the rates each May 1 and Nov. 1.

The silver lining is that rates can't fall below 0%, so I-bond holders won't lose their principal. What's more, "prices tend to go up in the first half of the year, so because of that, we'd definitely expect there to be a positive inflation component" the next time the rate resets, said Tom Adams, editor of www.savings-bond-advisor.com.

Over the long term, inflation-linked investments are still a good bet, experts say. "In the short term, inflation will be hard to detect because of the weak economy and lack of pricing power," says Greg McBride, senior financial analyst at Bankrate.com. "But over the longer term, the substantial debt issuance by the government and large ongoing deficits bode for higher inflation than what we've experienced in recent years."

Until rates pick up, the best option might be to "suck it up" while the bonds pay 0%, Mr. Adams says. I bonds typically lag behind returns on other investments, so its investors are coming off returns of 4.92%, while stock-market indexes fell around 40%, he says. Returns on Treasury Inflation-Protected Securities, by contrast, fell last year, but have started to inch higher as signs of inflation emerged in recent months.

For those thinking about cashing in I bonds after the one-year minimum holding period, be sure to find out what your bonds are earning now and when their rates will reset, says Mr. Adams. The Treasury has an online calculator at http://www.treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.