Why Are I-Bonds So Confusing?

The fixed rate of the I-Bonds were announced yesterday and it's 0.2%, down from 0.3% in November. If you add in the inflation adjusted semi-annual rate, the composite rate for the period between 5/1/2010 - 10/31/2010 is 1.74%. Since the prior composite rate was 3.36%, I decided to front-load my planned purchases and bought $300 on April 29.

What's really confusing about I-Bonds, though, is that I really can't compare the current composite rate to APYs offered by banks since the I-Bond rates change every 6 months. Additionally, I noticed something peculiar about my I-Bonds.

I already knew that:
1.) The applicable composite rates are announced every May 1 and November 1;

2.) The composite rates are applied every 6 months from the month of purchase. For example, I-Bonds that I buy in January will have the current composite rate until June 30. (And February purchases will have the current rate until July 31, so on and so forth.) The new composite rate for the January I-Bond will apply between July 1 to December 31. The next composite rate change will take place anew on January 1.

Although that's simple enough, I also discovered that the interest doesn't start accruing until 3 months after purchase.

Using my January 2010 $50 I-bond purchase as an example:

1.) The applicable composite rate at that time was 3.36% and would apply until June 30, 2010. Since it was just announced that the new composite rate is 1.74%, the new rate would apply between July 1 and December 31, 2010.

2.) The 3.36% interest didn't start accruing, however, until April 1, 2010. The I-Bond will continue to accrue at 3.36% until September 30, 2010. The bond will accrue at the new rate of 1.74% between October 1, 2010 and March 31, 2010.

If I sold the I-Bond in January 2011, after the requisite 1-year holding period, I would be penalized 3 months' worth of interest. In this case, I'm wondering if I'll be penalized the 1.74% interest that I will be accruing between 10/1/2010 - 12/31/2010. If so, my January 2010 I-Bond would only have a net effective interest rate of about 1.78% (if I sold after only 1 year). If you take into account that it's exempt from state tax, I guess it still beats the current 12-month CD rates that are available out there.

But still, that's a lot less than the 3.36% interest rate that I thought I was getting. And I may have been better off just sticking my money into my SmartyPig savings account that's yielding 2.01%.