Tom Talks Taxes - July 22, 2022

How to maximize Series I savings bond purchases while rates are high

I got a lot of feedback that my original article on inflation investments was helpful. Below I expand on that topic by focusing on strategies to acquire more significant amounts of I bonds right now while inflation is hot.

Series I savings bonds are now popular because their interest rates are high because inflation is high. For example, an I bond purchased between May 1, 2022 and November 1, 2022 will earn a 9.62% annual rate for the first six months (or 4.81% in six months). The rate adjusts every six months based on the inflation rate.

The owner must hold the I bond for at least one year. If a taxpayer redeems the bond within five years, the last three months of interest are forfeited.

Example: Bob bought a $5,000 Series I bond on May 25, 2022. Let’s assume that future I bond rates will be those shown below.

In this scenario, if inflation remains relatively high for the next two years, Bob can earn $1,446 of interest in that I bond over five years for a risk-free average rate of return of 5.8%. If Bob redeems the I bond after two years, he will lose the last three months of (lower) interest accruals but could earn an average rate of return of over 8%!

The tax benefits of owning Series I savings bonds include:

• The interest is tax-deferred until the bond is redeemed or the bond stops earning interest after 30 years (whichever is later),

• An election to claim the interest accrued each year is available, which may be ideal for children or lower-income taxpayers,

• The interest is exempt from state income tax, and

• An individual can exclude the interest income from tax if the bond proceeds are used for qualified higher education expenses under §135.

In periods of high inflation, the Series I bond is a significant potential investment to preserve capital. Of course, because of the possible high interest rates, the federal government restricts how many I bonds U.S. citizens and residents can purchase each year.

An individual can only buy up to $15,000 in I bonds directly in one year:

• $10,000 electronically via TreasuryDirect, and

• $5,000 paper via a federal tax refund.

There are two ways to buy I bonds beyond the $15,000 amount: use of business entities and use of trusts.

Business entity. A business can buy up to $10,000 in I bonds per calendar year. If an individual owns multiple business entities, each separate business entity can buy up to $10,000 per calendar year in its different account.

From the TreasuryDirect account registration page:

Example: Sean is single and owns two S corporations. He can personally buy $15,000 in I bonds, and each of his S corporations can buy $10,000 in I bonds for a total of $35,000 per year.

Trust. A trust can buy up to $10,000 in I bonds per calendar year.

From the TreasuryDirect account registration page:

Example: Mary and Laura are married, and each has a living revocable trust. They do not have a federal tax refund. Mary and her trust can each buy $10,000 in I bonds, and Laura and her trust can each buy $10,000 in I bonds for a total of $40,000 per year.

In addition to buying, a gifting strategy can allow an individual to accumulate I bonds over the $10,000 annual amount while not acquiring more than $10,000 per year.

Bonds purchased as a gift via TreasuryDirect go into a gift box. The recipient will not know a gift was given to them until the individual delivers the gift bond to the recipient’s TreasuryDirect account. The principal amount of delivered gifts will count against the recipient’s $10,000 annual purchase limit in the year of delivery to the recipient. Individuals can gift I bonds even if they bought the maximum for themselves.

Example: Lola is married to Kyle. On June 1, 2022, Lola purchased $10,000 in I bonds via TreasuryDirect. On July 29, 2022, Kyle put $10,000 in each of three gift boxes for Lola. Kyle makes a $30,000 gift to Lola in 2022; however, there is no gift reporting requirement because they are married. The I bonds will accrue interest beginning July 1, 2022 at the 9.62% rate within Kyle’s gift boxes.

If inflation rates continue to be high in 2023, Lola may want to buy $10,000 of I bonds in that year to lock in high rates; if she does, she cannot receive any of Kyle’s gift bonds.

If inflation rates are low in 2024 and I bond rates significantly decrease, Lola may not want to buy new I bonds at low rates. She can now receive up to $10,000 of Kyle’s gifted I bonds, which have accumulated large amounts of interest in 2022 and 2023. She can receive the total I bonds in one gift box since the principal amount is $10,000, even though the fair market value is higher with interest accruals.

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