I Bonds have a 30-year term, but you can sell them any time after 5 years with no penalty. My suggestion: Hold them until you really need the money.
By David Enna, Tipswatch.com
The I Bond’s new inflation-adjusted variable rate — a gaudy 7.12% for six months — is bringing a lot of fresh interest to these inflation-protected Savings Bonds. With all the media coverage, some investors have questions. Such as this one from a reader:
“I purchased I Bonds in 2011. Do you think I should sell those and purchase again or leave them as it is? I don’t want to increase my bond portfolio more than where it is.”
This very common question is understandable, but it comes from a basic misunderstanding of how I Bonds work — and after all, 95% of Americans have no idea how I Bonds work.
The new variable rate everyone is talking about — 7.12% for six months — applies to all I Bonds ever issued, not just the newly minted November 2021 version. Every I Bond is going to earn at least 7.12%, annualized, for six months, after the current variable rate of 3.54% ends its six-month term. So there is no reason to sell old I Bonds to buy this new November version, and in fact, there are good reasons not to sell I Bonds to buy the new one.
When the 7.12% variable rate kicks in will depend on when the investor bought the I Bond. Here is the schedule from TreasuryDirect:
(One confusing thing about this chart, however: I Bonds that are less than 5 years old will be listed on TreasuryDirect’s site and the Savings Bond Calculator without the latest three months of interest. TreasuryDirect notes: “When looking at changes in values for these bonds, rate changes will seem to be delayed by three months.” This confuses and frustrates a lot of investors.)
Why redeeming early can be a mistake
The reader who posed the original question purchased I Bonds in 2011. Through that entire year, I Bonds got a permanent fixed rate of 0.0%, exactly where it is now. So the value of this I Bond has grown about 20.9% over the last decade. With a $10,000 investment, the value is now about $12,090, roughly.
As I noted, there is no benefit to redeeming those 2011 I Bonds to purchase I Bonds in November 2021. The fixed rate remains at 0.0%, and all I Bonds will get the 7.12% variable rate for six months..
The big problem with redeeming early is that the interest earned will be immediately taxable as income on the investor’s federal tax return. The hit on $2,090 interest would be a tax of about $460 for someone in the 22% tax bracket.
To sum up: No benefit, with a cost of $460. Don’t redeem older I Bonds to purchase new ones in November 2021.
When does redeeming make sense?
I Bonds were first issued in September 1998 and those earliest ones won’t mature until September 2028, so maturing I Bonds are not an issue. (FYI: I Bonds issued in 1998 carry a fixed rate of 3.4% and will now be earning a composite rate of 10.64% for six months. Definitely hang on to those.)
My one premise for redeeming I Bonds is this: Don’t do it, until you really, really need the money. Because of the $10,000 per person per year purchase cap, it takes years to build up a sizable cache of inflation-protected I Bonds. If you redeem $10,000 in I Bonds, the purchase cap still applies, so your holdings can’t grow in that year.
Obviously, it doesn’t make sense to redeem I Bonds right now — for any reason — with a very generous interest rate taking effect for six months. And inflation could continue at a high rate well into 2022. Now is a great time to own I Bonds, not to sell them.
In the future, if you do need the money and decide to redeem:
- Redeem I Bonds you have held 5 years or longer, to avoid losing three months of interest.
- If the current variable rate is high — like it is now — let that rate run its six-month course before redeeming.
- Redeem I Bonds with a 0.0% fixed rate before any others. A higher fixed rate is always preferable. If you have been buying I Bonds for many years, you certainly have issues with 0.0% fixed rates. Redeem those first.
However, figuring out which I Bonds have a 0.0% fixed rate can be confusing, because the TreasuryDirect site will show you the issue date and the current interest rate, but not the fixed rate. The current interest rate can be confusing, because of the month-by-month rolling dates for interest rate changes. For example, your holdings right now might show interest rates of 3.54%, 3.64%, 4.05%, 3.74%, 7.12%, 7.22%, 7.43%, and so on. The ones with interest rates of 3.54% and 7.12% definitely have a fixed rate of 0.0%.
To sum up: Don’t be redeeming any I Bonds right now. Eventually, when you do redeem, carefully examine your holdings and redeem those with fixed rates of 0.0%.
Does it ever make sense to redeem I Bonds to buy new I Bonds?
Yes, I think so, under these circumstances:
- The new I Bonds have a substantially higher fixed rate than the I Bonds you will be redeeming. And then, even if that is true, only redeem if ..
- You need to raise the cash to buy the new, higher-rate I Bonds. Redeeming 0.0% I Bonds to purchase 0.5% I Bonds (which was possible from November 2018 through October 2019) makes sense if you have no other tax-efficient way to raise the cash.
I did this sort of rollover during that 2018 to 2019 stretch, unloading I Bonds with a 0.0% fixed rate to grab the new 0.5% fixed rate. That meant 1) my overall holdings did not increase in those years, and 2) I owed some taxes on the redeemed interest. Now, with that 7.12% interest pouring in, I guess I should have just held on and found the cash elsewhere.
Oh well, lessons learned.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.