Should You Redeem Your Series I Bonds? Here’s What to Consider:

Series I Bonds, also known as I Bonds, are a type of savings bond issued by the U.S. Treasury that offer investors a very low-risk investment vehicle option with a unique combination of a fixed rate and a variable inflation rate that is updated every six months. A couple of years ago, when inflation was peaking and reached levels of 10% and higher, the U.S. Treasury’s I Bonds became a hot commodity. They offered an attractive way to hedge against rising costs because their interest rates were tied directly to inflation. However, with inflation steadily moderating and edging closer toward the Federal Reserve’s 2% target, the interest rates on these bonds have significantly declined. If you hold I Bonds, now may be a good time to review your investment and consider redeploying your funds into higher-yielding opportunities.

Here’s what you need to know if you’re thinking about redeeming your I Bonds.

Where Are Your I Bonds Held?

I Bonds are held either in paper form (which is uncommon these days) or via  TreasuryDirect.gov. It’s important to note that I Bonds cannot be traded through custodians like Charles Schwab or Fidelity; as a result, our team at Coldstream Wealth Management is unable to directly manage I Bonds on your behalf. However, we can guide you through the redemption process and help you with strategies on how to reinvest those funds wisely.

When Can You Redeem I Bonds?

Timing is critical when redeeming I Bonds. Here are a few things to keep in mind:

1. One-year minimum holding period: You cannot redeem I Bonds until you’ve held them for at least 12 months.
2. Penalties for early redemption: If you redeem your bonds within the first five years, you’ll forfeit the last three months of interest. However, after five years, you can redeem your bonds without any penalties.
3. Best time to redeem: To maximize your interest earnings, consider redeeming on the first business day of the month. I Bonds accrue interest for the previous month on this day, and you won’t be penalized for missing out on a full month of interest as you would if you redeem at month’s end.

How Interest Works on I Bonds

Interest on I Bonds accrues monthly and compounds semiannually. That is, you earn last month’s interest on the first day of a new month, while every six months, the accrued interest is added to the bond’s principal value. However, the value you see on your TreasuryDirect account doesn’t include the interest that’s accrued but not yet added to the principal.

When you redeem the bond, you’ll receive all accrued interest, even if it hasn’t yet been applied to the bond’s balance. However, be mindful of the three-month penalty if you’re redeeming before the five-year mark.

Tax Considerations for Redeeming I Bonds

Another factor to weigh before redeeming I Bonds is how the accrued interest will impact your tax liability. Unlike most bonds, I Bonds offer tax-deferred interest, meaning you won’t owe federal taxes until you redeem them. When you do redeem your I Bonds, all the accumulated interest will be applied to your federal tax return for that year. I Bond interest is exempt from state and local taxes.

To avoid any surprises during tax season, it’s a good idea to consult with your Coldstream advisor before redeeming I Bonds, especially if there’s significant interest accrued. For example, if 2024 looks to be an unusually high-income year for your household, it might make sense to wait until 2025 to redeem your I Bonds. Together, we can develop a redemption strategy that aligns with your broader financial and tax planning goals.

Special Tax Benefits for Education Expenses

One unique feature of I Bonds is that the interest earned can be tax-free if used for qualified educational expenses. This could be a great option if you’re planning to pay for a child’s or grandchild’s education. To qualify for the exclusion:

•      The interest must be used in the same year it’s redeemed.
•      There are income limits to qualify.
•      You’ll need to submit IRS Form 8815 with your tax return

Keep in mind that if the accrued interest on redeemed I Bonds exceeds the education expenses paid in that year, that additional interest will be federally taxable.

What to Do After Redemption

Once you’ve decided to redeem your I Bonds, the next step is determining how to redeploy those funds. The cash from your redemption will generally need to be transferred from TreasuryDirect to another account, as the TreasuryDirect platform only allows reinvestment into other government bonds. This is where Coldstream can help you evaluate other investment options that align with your goals, such as higher-yielding bonds or other options that offer portfolio diversification.

Next Steps

If you’re considering redeeming your Series I Bonds, reach out to your Coldstream advisor for personalized guidance. We can help you decide on the right timing, strategize around the tax implications, and identify new investment opportunities that better suit today’s economic environment.

Staying informed and making smart, strategic decisions is key to preserving and growing your wealth. Let’s make sure you’re taking full advantage of your options.