Is It Time to Cash Out Your I-Bonds?

It seems like only a year ago we were dealing with such an intense rush to buy Treasury Series I Savings Bonds (now affectionately known to the general public as I Bonds) at their historically high 9.62% interest rate, that as the October 31st purchase deadline approached, the Treasury Department’s website could not keep up with purchaser demand. As many rushed to get their purchases in, they found themselves unable to access the site needed to do so.

Since that time, inflation rates have settled, and the one-year mandatory holding period has now passed on I-bonds purchased prior to November 1, 2022. This has led some to wonder if it’s time to bail on their I Bonds in search of better yielding pastures. Current I Bond rates for bonds purchased during that 2022 frenzy are now just under 4%, which means a one year CD would produce a higher yield than your I Bonds.

(To clarify – though the posted rate on the Treasury Direct site is 5.27% as of November 1, 2023, that also includes a fixed percentage rate of 1.3%, which only applies to newly purchased bonds. Unfortunately for those who purchased at the 9.62% rate, that fixed rate is set at 0%, so any I Bonds purchased from May-October 2022 are currently making 3.97%).

So, is it time to looks for a better yield on your safe money? It depends a lot on why you bought I bonds in the first place, and how you think about that money in terms of your overall financial picture.

I have a ton of clients who bought I bonds during that time, and most of them fall into 2 categories, and my advice for them would be different, depending on their situation.

1

Those who were holding a relatively short-term pile of cash for something like a home purchase or home-improvement project that was 2-5 years out.

2

Those who just generally had a chunk of money around that wasn’t earning much, that they didn’t have an immediate need for, and in many cases, still don’t.

If you’re in category 1, and you bought I bonds because you were looking for a short-term place to stash some cash safely and your 1 year holding period on I Bonds has now passed, I think it’s worth considering whether your short term needs can be better met elsewhere. With it currently being possible to find CDs in the 1-2 year time-frame that are yielding 5-5.5%, I bonds may no longer be giving you the best return on this money for the time frame you’re considering. And there may be better ways to earn a higher guaranteed interest rate in the short-term.

If you’re in category 2, and you still have no real foreseeable need for those funds, consider making I Bonds part of your new emergency savings fund and just letting these bonds ride the ups and downs of inflation. Prior to the one-year holding period, I Bonds can’t really act as an emergency fund because you can’t access the money. But once the holding period has passed, for I Bonds purchased electronically, it’s typically about a 2-business day wait to get those funds transferred back into your contributing account. (For paper-bond holders, the cash out process is a bit more involved, so paper I Bonds may not actually make the best emergency fund.)

If you’re working with an appropriate buffer savings account, with the idea that your emergency fund is really just there for the 2-3 times in your life that you might REALLY need a sizeable amount of money for a truly unexpected event, then I Bonds are sort of the perfect place for them because they are:

1

Out of sight, out of mind.

They’re just difficult enough to get to that you don’t really think of them as readily accessible money. That’s exactly what you want for an emergency fund, something you basically forget about.

2

Not going to lose value to inflation, which to me, is the most I’m really hoping to get out of “earning power” from my emergency fund.

I don’t want it to be worth less because inflation has eroded its value, but I don’t need it to be kicking inflation’s butt in terms of returns either. I bonds are the perfect vehicle for this. You can rest assured that inflation is not eroding their value without having to actively be involved in their management.

3

Flexible in terms of cash out amount; You don’t have to cash out the amount you put in.

You can pull out any amount above $25 and leave the rest to continue working for you (and preserve its holding period), and I Bonds can be rebuilt in smaller and more regular increments as well if you ever do need to draw on these funds.

Remember, the goal of emergency-fund safe money is not to make as much money as possible with it, it’s to keep you from having to borrow money at high interest rates in the event of some sort of unexpected financial catastrophe. And while chasing short-term returns on things like CDs may feel like the smart money move now, it doesn’t take too long of a look back into history to remember when CDs and high-yield savings accounts were returning 0.5%.

Whether you decide to cash out your I Bonds or not, there are a few additional considerations and risks to note.

If Cash Out is in Your Near Future

1

Be aware that cashing in an I bond any time before the full 5 year holding period results in a penalty equivalent to the last 3 months-worth of interest earned.The good news is you don’t have to factor this into your calculations of what your I Bonds are worth. If you log into your Treasury Direct Account and look at the value of your bonds, any bonds held for less than 5 years are showing the current value minus the most recent three months of interest, since that’s what you can cash out for today.

2

If inflation picks back up again in the next 2-3 years, and you decide you want to purchase I Bonds again, you’ll restart with a new holding period on new bonds purchased, and you’ll be subject to the one-year purchase limitation (which, in most cases, unless you’re out there working the loopholes, is $10,000 per person per year).

3

Interest on I Bonds is taxable, so if you cash out, you’ll owe income taxes on the interest that you’ve earned thus far.

If You’re Holding for the Long-Term

1

There are times/years when your I Bonds may not return anything. In years where the inflation rate drops to 0% or below, I Bonds that have a 0% fixed rate will be making 0%. In times like these, it’s good to remember that your I bonds are keeping up with inflation just fine, there just happens to be no inflation to keep up with.

2

Interest on I Bonds is taxable, and you have the choice to pay those taxes along the way or wait until you cash out (or when the bonds mature in 30 years, if you hold them to their full term). Either way you choose, make sure you’re keeping clear records and discussing with your tax professional. Since cash out or maturity is the only time Treasury Direct actually issues a 1099-Int, if you want to pay each year as interest accumulates, it will take some effort on your part to get into your account and see how much you’ve earned, and to keep track of the interest you’ve already paid on your earnings.

3

For people at some income levels, who meet certain conditions, I bonds (And Series EE Savings Bonds) have a similar tax advantage to 529 plans, which is to say, if you use them for higher education expenses for your children, you may not have to pay any taxes on the interest earned.

Is There Any Reason to Buy I Bonds Right Now?

I think if you like the idea of using I Bonds as a long-term emergency savings fund, but you didn’t quite get enough into them last year to fully fund your emergency savings need, a more steady approach to I Bonds purchases until you meet that goal could make sense for you.

Though most people were frantically attempting to put the max ($10,000) into I Bonds before the deadline last year, they don’t have to be purchased like that.

So, if you put $10,000 into I Bonds last year, but would really like to have your emergency fund up at around $20,000 or $30,000, you could set up a more gradual purchase plan (you can buy I Bonds in increments as small as $25, and it’s possible to set up a regular contribution/purchase on the Treasury Direct site, so that this can happen passively in the background of your accounts each month). An advantage to doing this is that bonds purchased at different times have different fixed rates, so for example, an I Bond purchased today has a 1.3% fixed rate that stays with it over the course of its lifetime, so that even if the inflation rate drops to 0% or below, that bond will still be returning 1.3% for you even in times of negative or no inflation. So while the current posted 5.27% rate isn’t quite as flashy as that 9.62% rate, there’s an argument to be made for a bond purchased today as a better “long-term” savings vehicle, since its overall interest rate will never actually drop to 0.

Attribution: Header image by TheKarenD on Flickr