ASK KIM


Hang on to I Bonds

Kimberly Lankford

I hold $63,000 in I bonds, which I bought in 2003. If I redeem them before five years, I face a three-month interest penalty. I was thinking of selling and buying CDs.



The interest rate on inflation-protected savings bonds, or I bonds, has declined from 6.7% to 2.4%. I hold $63,000 in I bonds, which I bought in 2003. If I redeem them before five years, I face a three-month interest penalty. I was thinking of selling anyway and buying CDs at 5.25%.

Hang on to the I bonds. The interest rate for I bonds has two components: a fixed rate that lasts for the 30-year life of the bond, plus an inflation adjustment that changes semiannually, in May and November. Bonds purchased from now until November 1 pay a fixed rate of 1.4% plus the inflation adjustment.

But investors who already owned bonds earn a different fixed rate. Depending on when you bought your bonds in 2003, you're earning either 1.6% or 1.1%. And individuals who purchased bonds before November 2001 may be earning a fixed rate of 3% or more.

Then there's the inflation component -- which is, after all, why you purchased the bond. The current inflation factor, which is 1% on an annualized basis, reflects consumer price index numbers from September 2005 to March 2006 -- a six-month period with "abnormally low inflation," says Dan Pederson, author of Savings Bonds: When to Hold, When to Fold and Everything In-Between. That rate is almost certain to rise in November, says Pederson, reflecting an uptick in inflation since March.

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Jack Quinn, founder of Savingsbonds.com, cites two other reasons for keeping your bonds: penalties and taxes. As you mentioned, you'd have to pay a three-month interest penalty if you cashed in the bonds before holding them for five years. And you'd owe taxes on the earnings when you cashed out, giving you less money to invest in the CD.

Think of I bonds as a long-term inflation hedge. "You're getting a good rate of return overall, and you have a shot at getting an even better rate a few years from now," says Quinn.

For more information about I bonds, see the Treasury Department's I bond page.

Got a question? Ask Kim at askkim@kiplinger.com.




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