The 101 on I Bonds

Before diving into a 101 on I Bonds, let’s first acknowledge that they’re the most boring investment that we’re recommending to… just about everyone*. If inflation is something that’s top of mind, they may be a good addition to your portfolio. For more on our thoughts on inflation, see our piece from a few months back.

What are I bonds?

I Bonds are a type of U.S. savings bond designed to protect the value of your cash from a rise in inflation. They are meant to give investors a return + inflation protection on their purchasing power. An I bond earns interest monthly from the first day of the month in the issue date.

Interest is paid in two components: a fixed rate of return plus a semi-annual variable rate which fluctuates with inflation.

How is interest calculated?

Currently, I bonds provide an interest rate of 7.12%, and this rate is good through April 30, 2022. A portion of this rate is tied to inflation, so the rate adjusts every six months, on May 1 and November 1.

How do I bonds work?

When you purchase an I bond, you pay the full face value of the bond. Bonds can be purchased two ways: paper I Bond certificates or electronically registered I bonds through the TreasuryDirect.gov website.

I bonds earn interest each month, and the interest is compounded every six months. However, you don’t get access to the interest until you cash out the bond. Interest that you earn gets added to the value of the bond twice per year.

How much can I purchase?

Investors can buy up to $10,000 worth of I bonds annually through the TreasuryDirect website. In addition, you can purchase another $5,000 by applying your federal tax refund towards a paper certificate purchase. For instance, a family of four would be able to purchase $40,000 in I bonds annually via TreasuryDirect.gov, and up to an additional $5,000 (per SSN, per year) if they had a federal tax refund in at least that amount.

When do I bonds mature?

I bonds have a maturity of 30 years, so you can earn interest on them for 30 years. NOTE: You cannot cash out of your I bond during the first 12 months of ownership. If the bond is cashed out between years 1 and 5, the most recent three months’ worth of interest is forfeited.

Do I have to pay taxes on I bonds?

I bonds are exempt from both state and local tax, but you do have to pay federal tax on the interest. However, if used to pay for college, the interest is completely tax exempt. For reporting taxes, there are two options: report interest annually or at maturity when the bond is sold.

How do I cash in my I bond?

This will depend on whether you own a paper bond or an electronic bond:

  • Paper Bond
    • Bring physical bond and proof of identity to a bank or financial institution that will cash it in (recommendation: call in advance, not all institutions accept).
  • Electronic Bond
    • Can cash out directly through the TreasuryDirect website.

Should I bonds be a part of my portfolio?

Although purchase amounts are quite limited, there are a few advantages to I bonds that make them a consideration for any portfolio:

  • Inflation protection
  • Less volatile than equities
  • Essentially no default risk, they are backed by the US Treasury
  • Interest is exempt from state and local taxes
  • Interest is exempt from federal tax if bonds are used to pay for college

*Disclosure: Everyone’s situation is unique. Please speak with a financial professional before following any of this advice.

End of Year Planning

Some end-of-year housekeeping and planning strategies to close out the year on a good note:

Review your portfolio:

  • with upcoming transitions in mind. Are allocation changes needed to begin preparing for an upcoming milestone (i.e. retirement) or transition (i.e. job change, relocation etc.)?
  • for (in)appropriate risk. Has your risk tolerance or risk capacity (i.e. how much risk you can take without interrupting other goals/priorities) changed? Can you now take on more/less risk?
  • for rebalancing opportunities. Is your portfolio properly allocated based on a target model? Or has your overall allocation drifted due to outsized gains/losses?
  • for gain/loss harvesting. If you invest in a taxable brokerage account, and depending on your tax bracket, there may be opportunities to realize additional capital gains (while in a lower tax) bracket or offset capital gains with losses.

Required Minimum Distributions (RMD)

  • What they are: The minimum amount that must be withdrawn from pre-tax retirement accounts annually once reaching age 72. This does not apply to post-tax Roth IRAs.
  • Inherited IRAs: Have their own rules.
  • Deadline: All RMDs must be taken by December 31st.

Contribute to a Roth or Traditional IRA

  • Roth IRAs: Contributions grow tax-free and qualified distributions come out tax free. Income limitations apply.
  • Traditional IRA: Contributions may be fully, partially, or non-deductible, depending on your income and circumstances.
  • Annual contribution limit (per person): For 2020, 2021, and 2022 is $6,000, or $7,000 if you’re age 50 or older. This limit applies to all IRAs. Example: An individual could fund a Roth IRA with $6k, or fund a traditional IRA with $6k, or fund each with $3k. You (or your spouse) must have taxable income in order to make a contribution.
  • Deadline: You can make 2021 IRA contributions until April 15, 2022.
  • Backdoor Roth: Depending on your circumstances, and for those who exceed the contribution/deduction income limits, you may be eligible to make a “backdoor” Roth contribution. Read more about it here and be sure to do it under the guidance of your financial planner and/or tax advisor.
  • Roth Conversions: If you are currently in a low tax bracket and expect your tax bracket to increase in future years, you may consider converting some pre-tax funds to your post-tax Roth. Essentially, paying taxes now so that your retirement funds can grow tax-free into the future. Deadline: 12/31/2021.

Charitable Donations

  • Deadline: All 2021 cash/non-cash donations must be completed by December 31st.
  • Deduction: Those that do not itemize their taxes can still deduct donations: up to $300 for single filers and $600 for joint filers.
  • Donor Advised Funds: Gifting appreciated stock to a Donor Advised Fund avoids recognizing capital gains and potentially pre-funds future year gifting.
  • QCDs: If over age 70.5, you can avoid recognizing IRA RMD income by directing some/all of your distribution to go directly to charity via a Qualified Charitable Distribution.

All advice listed here is for informational purposes. Please consult your financial planner or tax advisor before implementing.

 Federal Tax Proposal – A Summary

TAX

The Biden administration recently announced a number of tax proposals to fund new government investments. The current version may not be the final form, but many of its features are likely to become law. Below is a summary of what is most likely to impact families.

Income Tax Rates

  • Increase in the marginal tax rate: The top marginal tax rate would increase from 37% to 39.6% for income greater than $400,000 if you file as single and $450,000 if filed as married filing jointly (MFJ). These changes would go into effect for the 2022 tax year.

 

  • Increase in the top long-term capital gains rate: The highest marginal long-term capital gains rate would increase from 20% to 25% for incomes higher than $400,000 (single) or $450,000 (married filing jointly). The change in rate to 25% would be effective as of September 13, 2021 unless a sale was already under contract prior to that date.

 

  • S Corporations: Business profits from S corporations will be subject to a 3.8% surtax for taxpayers with Modified Adjusted Gross Income (MAGI) above $400,000 (single) and $500,000 (MFJ).

 

  • Section 199A QBI Deduction: To be phased out for those earning over $400,000 (single) or $500,000 (MFJ).

 

  • Additional 3% surtax on ultra-high income: An additional flat tax of 3% would be applied on any MAGI above $2,500,000 for individuals filing as married filing separately or above $5,000,000 for MFJ or single.

Retirement Strategies and Plans

  • Roth conversions will no longer be allowed for high income individuals:
    • New rules would prohibit all Roth conversions for taxpayers in the highest ordinary income tax bracket (39.6%) beginning January 1, 2032.
    • Roth conversions of after-tax funds will be prohibited for ALL taxpayers beginning January 1, 2022. This would eliminate backdoor Roth as a planning strategy.

 

  • Restricts contributions to IRAs or Roth IRAs for high net worth individuals if:
    • Taxable income is greater than $400,000 (single) or $450,000 (MFJ) AND the total value of IRA and defined contribution plans exceed $10,000,000.
    • The limitation does not apply to contributions of employer plans such as a 401(k), SEP IRA, or pension plan.

 

  • Change in Required Minimum Distributions (RMD) for individuals whose aggregate retirement account size exceeds $10,000,000:
    • Imposes RMDs on large retirement account balances if:
      • Taxable income is greater than $400,000 (single) or $450,000 (MFJ), AND
      • The total value of IRA and defined contribution plans exceed $10,000,000

 

  • If combined balance is between $10,000,000 and $20,000,000, the owner must distribute 50% of the amount of the account balances in excess of $10,000,000.
  • If the balance is greater than $20,000,000, the RMD would be 100% in excess of $20,000,000, plus 50% of any amount over $10,000,000.

Additional Changes

  • Wash Sale rule: This will be expanded to include cryptocurrency and other digital assets, commodities, and foreign currencies.

 

  • Estate Tax Exemption would be reduced: Would revert back to $5,850,000 per person and $11,700,000 per couple. This was scheduled to happen in 2026, but under the new proposal, it would get accelerated to 2022.

 

  • Increased child tax credit and monthly advance payment extended until 2025: Monthly advance payments of $250 per qualifying child aged 6-17 and $300 per child below the age of 6 would continue.

 

  • Assets held within grantor trusts may become part of taxable estate: This would potentially eliminate the benefit of certain estate planning techniques, namely Irrevocable Life Insurance Trusts (ILITs).