Redeem Older I-Bonds to Buy New Ones?

by Michael on Nov 6, 2013 · 2 comments

Image of Percentages on Blocks

As a quick followup to my I-Bond rate update, I just wanted to point out that the Treasury surprised everyone (or at least me) by increasing the fixed rate last week.

That’s the good news. The bad news is that they only increased it from 0% to 0.20%.

Regardless, you may now be wondering if it’s a good idea to redeem older bonds that are carrying a 0% fixed rate and use the cash to pick up some new ones with a higher fixed rate.

The right answer, to me at least, is that “it depends.” Whether or not it’s a good idea to trade your lowly old I-Bonds for new, higher paying ones depends on several factors that will vary for different investors.

Penalties and liquidity

For starters, you should be aware that you can’t redeem I-Bonds within the first 12 months. Period. Thus, if you bought within the past year, you’ll have to sit tight. But if you bought longer ago, redeeming and re-buying is an option.

That being said, from 1-5 years, there is a penalty of the last three months interest when cashing in an I-Bond. The impact of this penalty depends on prevailing interest rates, but it could be inconsequential or it could be more significant.

It’s also worth pointing out that you’ll be reducing your liquidity by redeeming and re-buying since you’ll re-start those one and five year clocks over when you re-purchase. In other words, your money will be locked up for the next year and subject to a three month interest penalty for the next five years.

Right now, the interest penalty for a 0% fixed rate I-Bond would be three months at an annual rate of 1.18%, so just a shade below 0.3% for three months. If you’re planning on holding your bonds for awhile, this could be a reasonable tradeoff.

Annual purchase limits

Finally, you need to keep in mind the annual purchase limit of $10k/person (plus $5k with your tax refund if you wish). Re-buying after redemption would count against this limit so you’d be giving up your ability to add to your I-Bond stash.

Honestly, I suspect that this is one of the main reasons for the annual purchase limit — to keep people from cashing in and re-buying en masse. Otherwise there would be massive turnover whenever they increased the fixed rate.

When does it make sense?

So, is redeeming and re-buying worth it? Maybe. If you’re not otherwise planning on buying your full allotment of I-Bonds this year, and if you’re planning on holding for a long time, then it could make sense to trade up for a (slightly) higher fixed rate.

This is especially true if you have some bonds bought between May and November of 2008. I say this because these bonds would now be clear of the interest penalty, and carrying a 0% fixed rate (the fixed rate first hit zero in May 2008).

In that case, you’d be trading a bit of time and some liquidity for a better rate.

1 krantcents November 6, 2013 at 8:22 pm

I own a TIPS mutual fund. It makes my decisions much easier.

2 Michael November 6, 2013 at 8:33 pm

Yeah, but TIPS and I-Bonds are different beasts entirely. They both provide a degree of inflation protection, but that’s pretty much where the similarity ends.

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