How, why, and when to rollover I bonds
Friday, November 3rd, 2006
Categorized as: Series I US Savings Bonds
Series I Savings Bonds have an interesting feature – the Treasury guarantees you a fixed base-rate for 30 years, but you only have to guarantee that you’ll hold an I bond for one year. When the fixed base-rate on new I bonds goes up, this feature allows you to roll your low base-rate I bonds into better ones.
How to rollover I bonds
There’s nothing special about rolling over I bonds. You redeem your old bonds and you invest in new ones.
However, as you can see in the following table, with the I bond fixed-base rate at just 1.4%, only I bonds issued in the last three and half years are suitable for rolling over now. Older I bonds already have better rates.
Series I Savings Bond fixed base-rates
|Issue Date||Fixed Rate|
|Sep 98 – Apr 03||1.60% – 3.60%|
|May 03 – Oct 03||1.10%|
|Nov 03 – Apr 04||1.10%|
|May 04 – Oct 04||1.00%|
|Nov 04 – Apr 05||1.00%|
|May 05 – Oct 05||1.20%|
|Nov 05 – Apr 06||1.00%|
|May 06 – Oct 06||1.40%|
|Nov 06 – May 07||1.40%|
One thing you have to keep in mind is that when you buy new I bonds, there’s a maximum annual investment limit of $30,000 per Social Security Number per year (this limit was reduced to $5,000 as of Jan 1, 2008). Paper I bonds and electronic I bonds at TreasuryDirect have separate limits, so you can invest $30,000 in each type for a total of $60,000 per SSN (now $5,000 for a total of $10,000).
If you have a lot of bonds to rollover, these purchase limits can prevent you from rolling them all over or they can prevent you from making additional investments. The limits are per calendar year, so if this is a concern, keep in mind that you can roll some over before the end of the year and the rest after January 1.
Why to rollover I bonds
What you gain when you rollover I bonds is a higher fixed base-rate. This means you’ll earn more interest every year from now on. For example, switching from 1.0% base-rate I bonds to 1.4% earns you an extra $4 a year per $1,000 of investment.
Since all of the I bonds suitable for rollover were issued less than five years ago, what you’ll lose when you do a rollover is an early-redemption penalty of the most recent three months interest.
But if your I bonds have been earning an inflation component of 1.00% for at least three months, the penalty on a 1.0% base-rate bond is just $5.00 per $1,000 of investment.
Redemption of your old bonds also means you’ll lose the tax-deferred status on the interest they’ve earned so far. Tax-deferment is a serious issue for many Savings Bond investors. Whether a rollover is worth it depends to some degree on what your tax rate is now compared to what it will be when you’d otherwise cash your I bonds.
If the tax-deferment doesn’t make any difference to you, you can earn $4 more per year for a one-time cost of $5. Obviously if you intend to hold on to your I bonds, a rollover can make sense, depending on how large your I bond investment is.
When to rollover I bonds
However, you have to minimize your penalty by redeeming after three low-interest months. The problem is that most I bond investors don’t understand when the interest rate on their bonds changes.
I bond interest rates are adjusted every six months beginning in the month in which the bond was issued. For example, this means that if you have I bonds that were issued in October and November, their rates change in different months. Most people think all I bond rates change at the same time, but it’s a lot more complicated than that!
An October I bond changes rates in April and October. Since new inflation components are announced one month later, in May and November, these updates get the inflation component announced five months earlier (which is based on the inflation that occured during the six months before that).
I bonds issued in October – or in April – just started earning the low 1.00% inflation component last month. You want to hold on to these until January so that you give up the low interest rate earned in Oct-Nov-Dec as your penalty. If you rollover now you’ll give up Aug-Sep-Oct interest, and two of those months earned an inflation component of 5.69%. Your penalty would be about $12.87 per $1,000 of investment.
The following table tells you when to rollover I bonds to minimize the penalty.
Don’t roll over I bonds before these dates!
|Issue month||Don’t rollover before|
|Jan or Jul||ok now|
|Feb or Aug||ok now|
|Mar or Sep||Dec 2006|
|Apr or Oct||Jan 2007|
|May or Nov||ok now|
|Jun or Dec||ok now|
There will be a lot more joy in rolling over I bonds when the fixed base-rate gets back to 3.0% or higher. At the current 1.4% level, it’s worth doing, but just barely.
For example, if your entire investment is one $500 I bond, rolling from a 1.0% fixed rate to 1.4% will earn you just an extra $2 a year.
Depending on the size of your investment, you could spend more in gas driving to the bank than a rollover will gain you. And don’t forget there’s a transaction processing cost that the Treasury has to pay on both your redemption and your purchase.