Yikes! Series I Savings Bonds paying 0.0%

John W. Schoen Senior producer • Profile • E-mail

With consumer prices under control — at least for now — inflation is no longer a big worry for most savers. But if you’re one of the inflation-averse savers who bought Series I savings bonds to protect you from inflation, you just got a nasty surprise.

Regarding Series I savings bond rates (now paying 0 percent) — will the inflation or fixed rates improve?
- C.P., Wisconsin

Call this the flip side of the government’s massive efforts to prop up the banking system and get the economy back on track. Low interest rates are great for lenders and borrowers. But they’ve made life a lot tougher for savers and retirees living off a lifetime of savings.

Series I bonds (the “I” is for inflation) are designed to protect you from the corrosive effect inflation has on the money you set aside for a rainy day. If you put away $100 today and inflation sends prices higher, your $100 won’t buy as much when that rainy day arrives.

To help get around this, Series I bonds come with two separate rates attached. The index rate, which is set when the bond is issued, is like the rate on any bond. It’s fixed for the life of the bond maturity (in this case 30 years), and you collect it no matter what happens to market interest rates.

The inflation protection comes in the form of a second, inflation-adjustment rate, which is set twice a year based on the Consumer Price Index. When prices are rising, you get, in effect, an extra bonus on your interest payments to offset the impact of inflation.

But lately, consumer prices have been falling, largely due to the collapse of oil prices. From September 2008 through March 2009, the CPI fell at an annualized rate of 5.56 percent. So when the inflation adjustment for Series I bonds was reset last week, it went negative —effectively wiping out any interest you’re due from the index rate. The overall return, however, cannot fall below zero.

That means your money is still safe from inflation, but you’re getting the same return you’d get by burying it in a coffee can in the back yard. Before you dump your Series I bonds and look for a higher return, here are a few things to keep in mind.

If prices really are falling, that means “deflation” is already pumping up the real value of your coffee can savings. If prices keep falling, your $100 rainy day fund will go farther when you decide to spend it in the future. So while your earning power has disappeared, you’re not losing buying power.

In fact, you’re still getting something of a break. The current index rate on the new Series I bonds is 0.10 percent. That’s less than you’d get with, say, a short-term CD, but not by much. When the Fed decides it wants to push short-terms rates to zero, it’s pretty hard to get out of the way.

You also need to look at the index rate when you originally bought the bond. If you’re holding a bond with a 5 percent index rate, you’ll get a decent return again once prices stop falling. Keep in mind that the current drop in prices will likely be short-lived. Given the Fed’s gigantic expansion of the money supply to force rates lower, many economists are worried about a possible surge in inflation down the road. If that happens, your Series I bonds will look a lot more attractive.

If you do decide to dump your Series I bonds, you’re in luck. Normally, if you sell a bond less than five years after you bought it, you have to pay a penalty equal to three months interest. Since you’re getting no interest, you’ll owe no penalty.

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