Want to Sell Your I Bonds? Watch Out for This Penalty

Selling I bonds can free up some cash, but there might be a cost to consider.

Many Americans bought Series I savings bonds, or "I bonds," over the past year or so as a way to protect their money from inflation and keep it away from the stock market. And it's easy to see why -- even after the I bond interest rate dropped a few months ago, these still offer a guaranteed 6.89% annualized initial return on your money for new buyers. That's significantly better than any CD account we know of.

However, if you're thinking about cashing out your I bonds, there are some key drawbacks you need to consider. So, here's what you need to know.

Can you sell your I bonds?

The good news is that there is a very liquid market when it comes to I bonds. This means you can sell them quickly and easily. If you have electronic I bonds, simply go to your TreasuryDirect account, go to ManageDirect, and use the link for cashing a bond. You can cash out your entire I bond, or you can do it in partial amounts as long as you leave at least $25 in your account. Paper I bonds can be cashed out in full, either at your bank (most branch-based banks will cash savings bonds) or directly through the Treasury Department by mail.

However, it's important to keep one thing in mind. I bonds cannot be redeemed at all until at least one year from the issue date. In other words, if you haven't held your I bonds for at least 12 months, there's no way to get your money yet.

Redeeming I bonds after one year

After one year has passed since the issue date, you have the ability to cash or redeem your I bonds through the methods discussed earlier. However, if fewer than five years have passed since the issue date, there is a penalty. By cashing in during the one-to-five year window, you'll forfeit the last three months' worth of interest the bond earned.

This can be a rather costly penalty in some cases. For example, let's say you bought $10,000 worth of I bonds three years ago. They've been accumulating interest at a rate of 6.49% for the past three months. By redeeming your bonds now, you'd still get significantly more than you initially paid thanks to the past year's inflation adjustments. But because you're still within the five-year window, you would get hit with a forfeited interest penalty of more than $160.

Keep in mind that the penalty is based on the last three months of interest, so it's a bigger issue during high-inflation periods. If you hold I bonds, and a year or two from now they're paying 1% or 2%, the penalty is significantly less.

As a final note, if you redeem your I bonds after five years have passed since the issue date, there is no penalty at all. You will receive the amount you paid plus all of the interest that has accumulated.

Should you still redeem your I bonds before five years?

The bottom line is that the early redemption penalty for I bonds isn't necessarily a deal-breaker if you need the money to cover expenses or because you find an opportunity to invest the money elsewhere. However, it should definitely be taken into consideration, especially during times of elevated inflation, as three months' worth of interest could be a significant amount of money.