Continue to Hold I Bonds or Sell Them?

If you are among the many who bought Series I bonds last year, like me, when they were yielding 9.62%, you are now (or will soon be) facing the decision of what to do next. You may well be looking at your holdings and asking the question popularized by The Clash: “Should I stay or should I go?”

There isn’t a clear answer, but there are some considerations I can share to help you determine the best move for you.

Let’s start with the yield. The interest paid on I bonds is based on a composite rate. The composite rate for I bonds issued between now through the end of October 2023 is 4.30%. It consists of a fixed rate of 0.90% and a semiannual inflation rate of 1.69%. The composite rate is calculated as [fixed rate + (2 × semiannual inflation rate) + (fixed rate × semiannual inflation rate)].

I bonds bought between May and October 2022 had a 0% fixed rate, so their current composite rate is 3.38%, not 4.30%. With online savings accounts and certificates of deposit (CDs) yielding more (e.g., Discover is offering AAII members 3.80% on savings and 4.55% on a 12-month CD), the current I bonds interest rate may not seem so enticing at first glance. But it’s not an apples-to-apples comparison.

Interest on Treasury bonds, including I bonds, is taxed at the federal level but not the state level. This boosts the tax-equivalent yield for I bonds. Illinois, for instance, levies a 4.95% income tax. The tax-equivalent yield for my fellow Illinois residents is 3.56% on I bonds bought one year ago [3.38% ÷ (1 – 4.95%)].

Furthermore, the interest on I bonds can be deferred for as long as you hold the bonds.

Not reflected in those yields is the penalty for selling I bonds held less than five years. If you redeem one within the first five years, you’ll lose the previous three months of interest. So, if you redeem an I bond purchased last May now, you’ll forfeit three months of interest that was paid at a 6.48% composite rate.

If you intend to sell the I bonds within five years of purchase, then you will have to decide which three months of interest you are willing to forfeit. I view this as the choice between what interest you will receive by continuing to hold I bonds and what you will gain from redeeming them and putting the proceeds into something else. The goal in such a situation is to make sure the interest rate (or return) of what you are switching to is high enough to warrant the change. The realization of taxes on I bonds may play a role in the decision—particularly for those who expect to be near a threshold for higher tax rates or higher Medicare premiums.

Treasury bills and notes are certainly competitive at current levels. Yields on the one-, three-, four- and six-month bills were all above 5% as of yesterday. One-year notes are yielding a juicy 4.70%. These yields are even juicier once adjusted for state tax exemptions.

There is no penalty for selling “traditional” Treasury bills, notes and bonds at any point prior to maturity. (The price you sell them at may be higher or lower than what you bought them at, however.) Unlike I bonds, there is no semiannual inflation adjustment for these Treasury securities, but their yields will vary on the open market.

The ongoing standoff over raising the debt ceiling is obviously making headlines. It seems likely that we will see more drama and further political posturing until the standoff is resolved. It could open up opportunities for someone who wants to be tactical and take advantage of the short-term volatility at the shorter end of the Treasury yield curve just as they did last year with I bonds. Doing so would be a personal decision to rotate from I bonds to a Treasury security.

The U.S. government has never defaulted, and failure to make interest payments on Treasury securities would have grave economic and financial market consequences.

Finally, consider how much you have in I bonds relative to your portfolios. The minimum purchase amount is $25. The maximum limits are $10,000 per year and up to $5,000 in paper I bonds by applying your federal income tax refund. There are ways to exceed this amount (e.g., have a spouse open a second account, use a trust to open another account, etc.), but the majority of you reading this likely have a small amount in I bonds relative to your total wealth. Therefore, it’s also worthwhile considering how much time and effort you want to put into the decision about whether to stay or go.

As for me, I’m currently in the “hold” camp since I bought my I bonds in May 2022 and do not want to forfeit the last three months of higher interest payments. That may or may not be the best decision for you.