Today's To-Do: Year-End Inflation and Tax Moves

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According to the US Labor Department, U.S. inflation hit a 39-year high of 6.8% last month. Meanwhile, in Washington, Democrats are scrambling to pass their $2 trillion “Build Back Better” spending bill before Christmas. While these two issues may not be directly related, they do offer either an opportunity or perhaps some urgency to act today.

The Inflation “Opportunity”

Everyone has felt the sting of high prices in the last year or so as strong demand for goods and services has been met with supply and labor shortages. Inflation, however, is a two-way street. As a consumer, it can be painful as prices for everything seem to be rising faster than income. On the other hand, if you sell the products or services that are more expensive, or work in a job that is in demand, you may be the beneficiary of higher prices or wages. Investors also may also see opportunity in inflation.

A current but somewhat limited opportunity for investors can be found in an area typically thought of as one of the most unexciting areas for investors, US Savings Bonds. Specifically, it is the I Bond variant of savings bonds that suddenly looks appealing.

I Bonds pay interest in two ways. There is a “Fixed Rate” + “Inflation Rate” that equals the “Composite Rate” that is the actual amount of interest that the I Bond will earn over a six-month period. The Fixed Rate is currently 0%, but the Inflation Rate for bond purchased by May 1, 2022 is 7.12% annualized Composite Rate! Even better, taxes on the interest aren’t due until the bonds are redeemed.

I Bonds have a 30-year maturity but they can be redeemed anytime after being held for the first 12 months. If redeemed between 12 months and 5 years, the “penalty” is the last 3 months of interest. If held for more than 5 years, I Bonds can be redeemed at any time with no penalty. So, even if the composite rate goes to 0% in the second half of 2023, a purchase made today redeemed in 12 months would effectively yield 3.52%, which is better than any bank, money market, or short-term bond currently offers.

I Bonds are 100% backed by the US Government and can be purchased through the TreasuryDirect website. However, I Bonds have a purchase limitation of $10,000 per person each calendar year. So that brings us to the potential Year-End move.

If you purchase a $10,000 I Bond before year-end, you can purchase another $10,000 I Bond in Janurary of 2022 for a $20,000 position. Couples can double that by each making purchases, totaling $40,000. Children, trusts, and estates can also make purchases. You can even apply up to $5,000 of a tax refund in addition to the annual $10,000 limit.

For investors with cash on hand that isn’t earmarked for immediate use or longer term investments, I Bonds present a very attractive current alternative.

Closing the Back Door?

Many ATX Portfolio Advisors clients take advantage of making after-tax IRA contributions and then converting those into Roth IRAs, a transaction also known as a “Back Door” Roth IRA contribution. The “Back Door” reference is due to the fact that those with adjusted gross incomes greater than $140,000 as individuals or $208,000 as joint filers are ineligible to make Roth IRA contributions. However, there is currently no income limitation on converting an existing IRA to a Roth IRA.

A Roth IRA conversion requires that the owner pays the taxes owed on the portion of a conversion that is pre-tax money. However, if the owner’s IRA solely consists after-tax contributions, there is no tax owed on the conversion. Thus, it is contributing to the Roth IRA via the “Back Door”.

While the final “Build Back Better” bill may look different than the one passed by the House, there is general sentiment that the Senate will probably not try and change the House’s elimination of the Back Door Roth IRA contribution beginning in 2022.

Thus, if you haven’t made a 2021 after-tax IRA contribution, you should do that now and convert before year-end. Additionally, if you have after-tax funds in a 401(k), you might wish to consider rolling those dollars over into a Roth IRA before year-end, if your plan allows. Most brokers are communicating that their year-end volumes may prevent them from guaranteeing they can process new requests by December 31, but acting today will be more likely to work than waiting until tomorrow.

If you would like to discuss your situation regarding either of these moves or any other planning issues, get in touch.

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