Interest Penalty for Cashing I-Bond early

Does anyone know how the early withdrawal interest penalty works on US Treasury I-Bonds? I am considering buying $10,000 of I-Bonds (the maximum), since the current rate is a hefty 9.6%. The bond has to be held a minimum of one-year and the rate is only guaranteed for six months. But even if the rate drops to 0% for the second six months (which, while unlikely, could theoretically happen if inflation drops to zero), that still averages to 4.8% for 12 months which isn’t bad.

But here is the problem. If you cash the bond in before five years, you incur a three-month loss of interest penalty. The question is…how do they calculate the three months of lost interest? Is it the last three months of interest, which would be at 0%? That would keep the blended rate at 4.8% for the year. But if they base it on the initial rate of 9.6%, then that means you only get that rate for three months, so your effective annual rate is 2.4%. That’s a pretty big difference.

The help on the Treasury Direct site seems to imply it’s the rate at the time you cash the bond in, but I have heard other sources that it may be based on the initial rate when you buy the bond. Unfortunately, the Treasury department is not accepting email inquiries right now and the wait if you make a phone call is a minimum of two hours.

Anyone know definitively how the penalty works?

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Tweet David Enna at @tipswatch on Twitter. He’s the maestro. He will tell you

Not sure if I can explain this in the 280 characters limit on Twitter, but I’ll give it a try. Thanks!

I did tweet David Enna, but while waiting for a response I stumbled on this You Tube video that explains everything perfectly.

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