The move comes as the Government looks to remove all other undated gilts in its portfolio, some of which have origins going back to the 18th century.
The 3.5 per cent War Loan is the most widely held of any UK Government bond with more than 120,000 holders, or 60 per cent of all holdings of government gilts.
About 97,000 of these investors hold less than £1,000 and almost 38,000 holders own less than £100, the Treasury said.
The 3.5 per cent War Loan was issued in 1932 by the then-chancellor Neville Chamberlain in exchange for the five per cent War Loan 1929-47, which was issued in 1917 as part of the effort to raise money to pay for the First World War.
The Debt Management Office estimates that Britain has paid some £5.5 billion in total interest on the five per cent and 3.5 per cent war loans since 1917.
Today’s move goes further than an announcement in October when the Chancellor said he would redeem a much smaller war bond, the first planned repayment of an undated gilt of this kind by government for 67 years.
Current low interest rates mean the Government will be able to refinance the debt with new bonds. The Treasury will redeem the outstanding £1.9 billion of debt from the 3.5 per cent War Loan on March 9.
Mr Osborne said: “This is a moment for Britain to be proud of. We can, at last, pay off the debts Britain incurred to fight the First World War.
“It is a sign of our fiscal credibility and it’s a good deal for this generation of taxpayers. It’s also another fitting way to remember that extraordinary sacrifice of the past.”
The Government will look to remove all six of the other remaining undated gilts in its portfolio, including some debt originally issued in the era of the South Sea Bubble in the 18th century.