Cashing I Bonds Early: How the Three-Month Penalty Works

Cashing an I bond before it turns five costs you the last three months of interest and nothing more, so the decision to redeem early comes down to one comparison: the dollars you forfeit against the extra dollars the money would make somewhere else. This guide is for anyone holding an electronic I bond bought when rates were high, now earning less, and somewhere between one and five years old. It shows what the penalty takes, works through an example with the arithmetic laid out, and gives you a rule to apply to your own bond.

If your bond is less than a year old, none of this applies yet, because it can't be cashed at all. And if you hold paper bonds and need help redeeming them at a bank, or you want a forecast of where I bond rates go next, this isn't the right page.

The two clocks: the 12-month lock and the five-year mark

Every I bond runs on two clocks that start on its issue date. According to TreasuryDirect's I bonds page, you can cash an I bond after 12 months, but cashing it before 5 years forfeits the last 3 months of interest. The same page says an I bond earns interest for 30 years unless you cash it before then.

That gives you three phases. In the first year, the money is locked. From year one to year five, you can get it out, at the cost of three months of interest. After year five, there's no penalty, and the bond keeps earning until it stops at 30 years. Interest is added to the bond monthly, and there's no credit for a partial month, so cashing on the 29th of a month gains you nothing over cashing on the 2nd.

What the three-month penalty actually takes

The penalty is interest, not principal. You never lose the money you put in; you give up the interest the bond credited in its final three months before you cash it. That makes the cost easy to estimate:

Penalty ≈ current bond value × current annual rate × 3 ÷ 12

This is a slight simplification, since interest compounds and the rate can change partway through those three months, but it's close enough to make a decision. On a bond worth $10,800 earning a hypothetical 3% a year, the penalty is about $81 ($10,800 × 0.03 × 3 ÷ 12).

Notice what drives the size: the rate during those last three months. A bond that has dropped to a low rate is cheap to cash, because three months at a low rate is not much interest. The lower your bond's current rate, the smaller the penalty and the stronger the case for moving the money, which is exactly the position many people who bought at high rates are in now.

Worked example: cash now or wait

Say you bought a $10,000 I bond three years ago. It's now worth a hypothetical $10,800 and earning a hypothetical 3% a year. You have 24 months to go before the five-year mark. The alternative is a high-yield savings account paying a hypothetical 4.5% a year. To keep the arithmetic readable, the example uses simple interest and assumes both rates hold steady for two years, which in real life they won't.

In this example, moving the money leaves you $235.71 ahead ($11,683.71 − $11,448) before taxes. The penalty was real, but small next to a 1.5-percentage-point rate gap held for two years.

The decision rule

You don't need a full table every time. Compare two numbers:

• The penalty in dollars: value × I bond rate × 3 ÷ 12. In the example, $81.
• The extra interest the alternative would bring in over the months you're comparing: value × (alternative rate − I bond rate) × months ÷ 12. In the example, $10,800 × 0.015 × 24 ÷ 12 = $324.

If the second number is clearly bigger, moving the money wins. Here, $324 − $81 = $243, close to the table's $235.71; the shortcut runs slightly high because it ignores that the $81 you forfeit can't earn interest in the new account.

A handy rearrangement tells you how long the alternative has to stay ahead for the switch to pay off: break-even months = 3 × I bond rate ÷ (alternative rate − I bond rate). With 3% against 4.5%, that's 3 × 3 ÷ 1.5 = 6 months. If the gap were only half a point, 3% against 3.5%, it would be 3 × 3 ÷ 0.5 = 18 months. The narrower the gap, the longer it needs to last, and the less sure you can be that it will, since both rates can change.

Adjusting for state tax

The comparison above flatters the savings account slightly, because the two kinds of interest aren't taxed the same way. TreasuryDirect states that I bond interest is subject to federal income tax but not to state and local income tax. Bank interest is generally taxable by your state if it has an income tax. With a hypothetical 5% state rate, the savings account's $964.71 of interest would cost about $48.24 in state tax ($964.71 × 0.05), leaving the switch ahead by about $187.47 ($235.71 − $48.24). Still worth it here, but in a high-tax state with a narrow rate gap, this adjustment can flip the answer.

Time your redemption around the rate reset

Since the penalty takes your last three months of interest, it matters which rate those months were earned at. An I bond's rate is made up of a fixed rate, set when you buy and kept for the bond's life, and an inflation rate that changes twice a year. Each bond moves to a new rate every six months, on a schedule tied to its own issue month, and your TreasuryDirect account shows what your bond is currently earning.

Suppose your $10,800 bond earned a hypothetical 5% for its last rate period and has just reset to 3%. At 5%, a month's interest is about $45 ($10,800 × 0.05 ÷ 12); at 3%, about $27 ($10,800 × 0.03 ÷ 12). Cash after one month at the new rate, and the forfeited three months are one at 3% and two at 5%: about $117 ($27 + $45 + $45). Wait until three full months at 3% have been credited, and the forfeited months are all at the lower rate: about $81 (3 × $27). Waiting saves about $36 in penalty, because you keep the higher-rate months instead of handing them back.

The reverse also holds. If your bond's rate has just gone up, cashing soon after the reset forfeits mostly lower-rate months, and waiting longer means giving back more expensive ones. Either way, check the rate history on your bond before choosing a date.

When cashing early makes sense

The arithmetic favors cashing early in a few common situations:

• You're carrying high-interest debt. A credit card charging well into double digits costs far more per month than a low-rate bond earns, and the three-month penalty is small by comparison. Putting the money toward a debt payoff plan is usually the clearest win.
• A safe alternative pays clearly more, for longer than your break-even period. If the break-even works out to a few months and you'd leave the money in place for a year or more, the switch has room to absorb a rate drop.
• You need the cash anyway. If a planned expense is coming, cashing the bond can be cheaper than borrowing. The penalty is a known, capped cost.

And there are cases where holding on is the better call:

• Your bond has a fixed rate above zero. That part of the rate lasts for the bond's life. If newer bonds carry a lower fixed rate, cashing gives up something you can't get back.
• The gap is narrow or likely temporary. A half-point advantage needs a long run to beat the penalty, and savings rates can fall quickly.
• You may want back in later. TreasuryDirect's limit is $10,000 in electronic I bonds per Social Security Number per calendar year, so money you take out can't all be put back at once.

Partial redemptions and the $25 you leave behind

You don't have to cash the whole bond. TreasuryDirect's page on cashing EE and I bonds says an electronic bond can be cashed in part, in any amount of $25 or more to the penny, and that if you cash only part of what a bond is worth, you must leave at least $25 in your account.

On a bond worth $10,800, you could cash $6,000 to clear a debt and leave $4,800 in place, and the part you leave keeps earning as before. What you can't do is cash, say, $10,790 and leave $10; you'd either cash the whole bond or leave at least $25. A partial redemption is useful when you need a specific amount, or when you want to move some money now and keep the rest until the five-year mark.

Taxes when you cash out

The tax side is simple at the state level and needs a little planning at the federal one. Per TreasuryDirect's I bonds page, the interest is subject to federal income tax but not state or local income tax, and if you use the money for qualified higher education expenses, you may not have to pay tax on the earnings.

If you haven't been reporting the interest each year, cashing out brings all the interest the bond has built up into a single tax year. On the example bond, that's $719 of interest ($10,719 received minus the $10,000 you paid), not just the most recent months. For most people that's a modest amount, but if you're holding several bonds or you're near the edge of a higher bracket, spreading redemptions across two calendar years can soften it. Whether that matters for you depends on your income and other deductions, so it's worth asking a tax professional if the amounts are large or you're counting on the education exclusion.

What you'll need before redeeming online

Check who is allowed to cash the bond first. TreasuryDirect's registration page explains that with an owner and a beneficiary, only the owner, the person named first, may cash in the bond. On an electronic bond with two owners, the first-named is the primary owner; TreasuryDirect's savings bond glossary says the primary owner can give the secondary owner View rights or View and Transact rights, and only with Transact rights may the secondary owner cash the bond.

Login requirements are changing. TreasuryDirect's ID.me FAQ says ID.me can be set up through TreasuryDirect from September 13, 2026, and that after October 28, 2026, it will be the only way to log in. Setting it up needs your Social Security Number and a valid government-issued photo ID, such as a driver's license, state ID, passport or passport card. ID.me may also ask you to verify with your phone's camera, or you can verify in a live video call with an ID.me Trusted Referee. If you plan to cash a bond around those dates, set this up ahead of time rather than on the day you need the money.

Finally, confirm the bank account linked to your TreasuryDirect account is current, since that's where redeemed funds go. Have your bond's current value and rate in front of you, run the penalty and break-even numbers above, and pick a redemption date that falls after the month's interest has been credited.