Redeeming I-bond for TIPS

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Norris
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Redeeming I-bond for TIPS

Post by Norris » Wed Nov 19, 2008 12:18 pm

I have an I-bond issued October, 2003 that pays 1.10% fixed rate plus inflation. It is in my treasurydirect account. I would like to redeem it and purchase TIPS.

I would appreciate any info on how I should do it:
I've never cashed one in before and so I don't know if the proceeds can "sit" in the TD account and if so, should I do that and wait for the January auction (I want to purchase 10year TIPS) or:

Should I redeem it and purchase on the secondary market thru Vanguard? I've never purchased individual TIPS but recently acquired the VG fund.

Norris
Life is really simple, but we insist on making it complicated. Confucius

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cflannagan
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Re: Redeeming I-bond for TIPS

Post by cflannagan » Wed Nov 19, 2008 12:27 pm

Norris wrote:I have an I-bond issued October, 2003 that pays 1.10% fixed rate plus inflation. It is in my treasurydirect account. I would like to redeem it and purchase TIPS.

I would appreciate any info on how I should do it:
I've never cashed one in before and so I don't know if the proceeds can "sit" in the TD account and if so, should I do that and wait for the January auction (I want to purchase 10year TIPS) or:

Should I redeem it and purchase on the secondary market thru Vanguard? I've never purchased individual TIPS but recently acquired the VG fund.

Norris
I'm not an expert, but I think there's a general consensus that one should not have TIPS in a taxable account (I-Bonds differs from TIPS on this matter, as far as tax treatment goes).

dbr
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Re: Redeeming I-bond for TIPS

Post by dbr » Wed Nov 19, 2008 12:36 pm

Norris wrote:I have an I-bond issued October, 2003 that pays 1.10% fixed rate plus inflation. It is in my treasurydirect account. I would like to redeem it and purchase TIPS.

I would appreciate any info on how I should do it:
I've never cashed one in before and so I don't know if the proceeds can "sit" in the TD account and if so, should I do that and wait for the January auction (I want to purchase 10year TIPS) or:

Should I redeem it and purchase on the secondary market thru Vanguard? I've never purchased individual TIPS but recently acquired the VG fund.

Norris
You can use the redeem bonds links on Treasury Direct. You have a linked personal banking account on TD. The proceeds will be deposited there. If you want to buy a TIPS bond at auction you can follow the instructions at TD for that. The purchase will be funded from your same linked bank account.

Tramper Al
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Re: Redeeming I-bond for TIPS

Post by Tramper Al » Wed Nov 19, 2008 12:56 pm

cflannagan wrote: I'm not an expert, but I think there's a general consensus that one should not have TIPS in a taxable account (I-Bonds differs from TIPS on this matter, as far as tax treatment goes).
Well, it's generally so that you would prefer to locate TIPS in tax-deferred, it does depend on circumstances and there is [no] absolute reason against holding taxable TIPS.

For example, the OP may be or will be in a relatively low marginal tax situation.

Or, the OP may have worked out that current real yields on TIPS have a greater expected return to maturity than do his 1.10% fixed I-Bonds on an after tax basis, even considering ongoing taxation of the TIPS and forfeiture of the tax-deferred treatment of the I-Bonds. It would not surprise me at all if this were the case for a fairly wide range of time horizon, tax rate, and inflation assumptions.

If I've understood all the threads on TIPS and I-Bonds, though, the lagged CPI-U effect on I-Bonds is relevant at the moment. I believe we are in a period where I-Bonds are paying nominally more for a past 6 month period of inflation, while TIPS are already being nominally devalued for the very recent deflation. This difference may figure into optimal timing for any I-Bonds to TIPS swap.
Last edited by Tramper Al on Wed Nov 19, 2008 2:01 pm, edited 2 times in total.

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Mel Lindauer
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Re: Redeeming I-bond for TIPS

Post by Mel Lindauer » Wed Nov 19, 2008 1:28 pm

Tramper Al wrote:
cflannagan wrote: I'm not an expert, but I think there's a general consensus that one should not have TIPS in a taxable account (I-Bonds differs from TIPS on this matter, as far as tax treatment goes).
Well, it's generally so that you would prefer to locate TIPS in tax-deferred, it does depend on circumstances and there is absolute reason against holding taxable TIPS.

For example, the OP may be or will be in a relatively low marginal tax situations.

Or, the OP may have worked out that current real yields on TIPS have a greater expected return to maturity than do his 1.10% fixed I-Bonds on an after tax basis, even considering ongoing taxation of the TIPS and forfeiture of the tax-deferred treatment of the I-Bonds. It would not surprise me at all if this were the case for a fairly wide range of time horizon, tax rate, and inflation assumptions.

If I've understood all the threads on TIPS and I-Bonds, though, the lagged CPI-U effect on I-Bonds is relevant at the moment. I believe we are in a period where I-Bonds are paying nominally more for a past 6 month period of inflation, while TIPS are already being nominally devalued for the very recent deflation. This difference may figure into optimal timing for any I-Bonds to TIPS swap.
Al is correct. In The Bogleheads' Guide to Investing, we provided tables comparing the after-tax returns of TIPS vs I Bonds in taxable accounts, using a number of holding periods, tax brackets and inflation scenarios.

We found that when the TIPS real rate is greater than .5% more than the I Bond fixed rate, the TIPS won in nearly all cases. With TIPS currently yielding ~3% real and the I Bond 1.1%, the TIPS would most likely be the runaway winner.

Regards,

Mel

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cflannagan
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Post by cflannagan » Wed Nov 19, 2008 1:33 pm

I stand corrected then - thanks for the additional info, it was education for me.

Tramper Al
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Re: Redeeming I-bond for TIPS

Post by Tramper Al » Wed Nov 19, 2008 1:42 pm

Mel Lindauer wrote:Al is correct. In The Bogleheads' Guide to Investing, we provided tables comparing the after-tax returns of TIPS vs I Bonds in taxable accounts, using a number of holding periods, tax brackets and inflation scenarios.
Hi Mel,

May I just say that the tables - and even moreso the spreadsheet used to derive them - are very helpful. At least if I can work out TIPS vs. I-Bonds in taxable, that's a good head start on the more complex tax-deferred space decisions.

I was just fiddling with the spreadsheet, and plugged in a negative number for inflation - you know, de-flation. I'm not sure it's working, though, as the output looks kind of goofy.

An I-Bonds question, though. Ignoring the 3-month interest penalty for now. My impression is that the I-Bonds deflation floor is immediate and periodically raised. That is, for any 6-month period (of deflation), you will always receive at least your fixed rate (say 0.7%), and the redemption value never nominally decreases. Is that so? And if in Year 1 of an I-Bond it was all deflation, would the CPI-U have to get back to its starting point before you'd begin to get a positive adjustment for inflation in Year 2?

You see, I am trying to appreciate the I-Bond as a short term nominal cash instrument as well.

Thanks in advance, all . . .

Norris
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Re: Redeeming I-bond for TIPS

Post by Norris » Wed Nov 19, 2008 3:02 pm

Thanks cflannagan, dbr, Al and Mel. I wasn't sure but I thought TIPS (at least presently) would win hands-down over a 1.1% I-bond. The tax ramifications are a good point. I will probably be in the 15-20% tax bracket for 2008.
Guess I'll hold off for the auction in January..hope TIPS will be as lucrative then as now.

Norris
Life is really simple, but we insist on making it complicated. Confucius

jhd
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Post by jhd » Wed Nov 19, 2008 3:57 pm

TIPS are probably better than I-Bonds as an investment right now. But I'm going to hold onto my I-Bonds and consider them part of my emergency cash reserves. 12 months after purchase, they make a nice cash-like savings vehicle.

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Mel Lindauer
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Re: Redeeming I-bond for TIPS

Post by Mel Lindauer » Wed Nov 19, 2008 5:40 pm

Tramper Al wrote: An I-Bonds question, though. Ignoring the 3-month interest penalty for now. My impression is that the I-Bonds deflation floor is immediate and periodically raised. That is, for any 6-month period (of deflation), you will always receive at least your fixed rate (say 0.7%), and the redemption value never nominally decreases. Is that so? And if in Year 1 of an I-Bond it was all deflation, would the CPI-U have to get back to its starting point before you'd begin to get a positive adjustment for inflation in Year 2?

You see, I am trying to appreciate the I-Bond as a short term nominal cash instrument as well.

Thanks in advance, all . . .
Hi Al:

First, the I Bond inflation adjustment can be positive (for inflation) or negative (for deflation), and that gets added to (or subtracted from) your fixed rate (remember, it's the fixed rate PLUS inflation and that can be postive or negative).

However, you never lose the interest you've previously earned, even in a serious bout of deflation. And the fixed rate never goes below zero, no matter how bad deflation might get.

So, you'd basically sit on hold until the total of the inflation adjustment and your fixed rate were postive again.

Finally, if delfation were to hit right after you purchased your I Bonds and continued for the entire period you owned your I Bond, you'd never get back less than you paid, even if you didn't hold for five years, since the penalty is loss of the last three month's interest, and that equals zero.

Inflation or deflation, I Bonds and TIPS protect your future spending power.

Regards,

Mel

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