Penalties for Cashing in a Savings Bond Early

The United States Treasury allows investors to redeem savings bonds before they reach maturity. This option isn’t available with most types of bonds. However, you may incur a penalty if you cash in savings bonds too soon. Even if you avoid the penalty, redeeming savings bonds early means you might lose an opportunity for a better return on your investment.

The federal government sells Series EE and Series I electronic savings bonds directly to individuals and organizations through TreasuryDirect.gov. Paper savings bonds are no longer sold, but early redemption rules are the same as for electronic bonds. Savings bonds are non-transferable, which means you can’t transfer ownership to someone else. Savings bonds mature in 30 years, but you can redeem them anytime starting one year after you purchased them.

If you elect to cash in Series I or EE savings bonds less than five years after you buy them, you forfeit three months interest as an early redemption penalty. You get back all of the money you originally invested plus the interest earned up to three months prior to the time of the redemption. The Treasury Department doesn’t charge any fees when you redeem savings bonds. After the five-year mark has passed, there is no penalty for early redemption.

The Treasury Department guarantees that Series EE bonds sold since May 2005 will at least double in value in 20 years. This promise does not apply to Series I bonds or to EE bonds issued before May 2005. This means that cashing in an EE bond before the 20-year mark can be an expensive mistake. Suppose you buy an EE bond when the fixed interest rate is 1.5 percent. After 19 years, the bond will be worth about one-third more than you paid. But if you wait just one more year, the Treasury Department will adjust the bond’s value so that it’s worth twice what you paid. After the 20-year point, the bond continues to earn interest at the original fixed rate until it matures at age 30.

The interest you earn on savings bonds is not subject to state or local income taxes, but you do pay federal income tax on the money. You can report interest earned and pay the income tax each year, or you can defer the taxes until you redeem the bond. If you cash in a savings bond early, all interest that you haven’t already reported becomes taxable in the year of the redemption. If your saving bonds have accrued a lot of interest, this can saddle you with a hefty tax bill. You can avoid taxes on savings bond interest entirely if you use the money to pay qualified education expenses. You have to be the owner of the bond, at least age 24 and use the money to finance education for yourself, your spouse or your dependents.