Picking up Nickels

Friday, August 25, 2006

Should You Sell Those Savings Bonds?

You asked:

"I have some I Bonds that I bought in April 2003. How much would they be worth if I cashed them in today and what is the interest rate (and is it fixed or adjustable)?"

The person that asked this question has some I Savings Bonds ("I" is for inflation) that they are considering selling to pay some bills.

To help make an informed decision, let's start by taking a quick look at I Savings Bonds (I Bonds). I Bonds are a savings product issued by the United States Treasury, which are designed to earn you interest and protect you from inflation. Here are some characteristics of I Bonds that are relevant to this discussion:

  • The interest rate is made up of two parts:
    • A fixed interest rate that is set when the bond is purchased
    • A variable interest rate (reset every 6 months) based on Consumer Price Index (CPI-U) data
  • Interest is paid on the first day of each month
  • Like T-Bills, I Bond interest is exempt from state and local income taxes
  • Tax on interest is deferred until the tax year the bond is redeemed
  • They must be held for a minimum of 12 months
  • If they are sold less than 5 years after the purchase date, the last 3 months of interest are forfeited.

Now, suppose you bought a $1000 I Bond in April 2003. Using a savings bond calculator from TreasuryDirect or Savings Bond Advisor, we can see that as of August 2006 this bond is worth $1,140.80 and currently has an interest rate of 7.35% (1.6% fixed, 5.5% variable).

Since this bond is less than five years old (and 3 months worth of interest would be forfeited upon redemption), you would be giving up interest earned at 7.35% if you redeemed it now. If you wait a few months, you can keep all of that interest earned at 7.35%.

In October, the variable portion of the interest rate for this bond will be readjusted and it will be earning an interest rate of 2.61% (1.6% fixed, 1.01% variable). If you want to cash in this bond, I would wait until at least December 2006 since you would forfeit 3 months of interest at the much lower rate of 2.61%.

Also, since the interest for December will be paid on the first day of the month, I would redeem the bond on December 1st. Since your I Bond is worth the same amount of money if you redeem it on December 1st or December 31st, you can maximize your return by redeeming the bond early in the month and putting the proceeds in some other interest-bearing investment.

For more information on investing in US Savings Bonds, I recommend you check out TreasuryDirect.gov, Tom Adams' (author of Savings Bond Advisor) Savings Bond Advisor site and Mel Lindauer's (co-author of The Bogleheads' Guide to Investing) I Bond Tutorial.

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