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.

In addition, our Tom Talks Taxes cocktail hour is this Sunday. If you are in Las Vegas for the NATP or NAEA events, or are local, I hope you will join us! -Tom

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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