Q3 2022 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), year-to-date, last 12 months, last five years, last ten years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (7/1/22-9/30/22)
Year-To-Date (1/1/22-9/30/22)
Last 12 Months (10/1/21-9/30/22)
Since COVID Low (3/23/20-9/30/22)
Last 5 Years (10/1/17-9/30/22)
Last 10 Years (10/1/12-9/30/22)

A few notes:

  • After spending the first half of Q3 building up significant gains, all asset classes struggled in the second half, closing down for the quarter, and, with the exception of Commodities, down for the year. International Stocks, both Emerging and Developed markets, as well as US Real Estate performed worst (-11% to -12%) for the quarter. “Best” performers for Q3 were High-Yield (junk) bonds, Short-Term Corporate Bonds, and US Small Caps (all down ~2%). US Large Caps (S&P 500), Commodities, Emerging Market Bonds, and US Aggregate Bonds finished the quarter in the middle of the pack, down 5-6% each.
  • The turning point for the market was the Federal Reserve’s annual meeting in Jackson Hole in August. There, chairman Jerome Powell reiterated a tough stance against inflation, indicating the Fed was poised to continue to raise rates considerably and willing to accept the “pain” (likely recession) that would result, in order to tame inflation.
  • As a result of the Fed’s action, bonds had another tough quarter too in Q3. Long-term treasuries (TLT, not shown above) were down another 11.6% in the quarter, now down ~31% YTD as rates spiked, and prices (which are inversely correlated with rates) sank. We generally keep the bond side of client portfolios much shorter in duration, and include inflation-protected bonds, both of which faired much better again. Short-term inflation protected treasuries were only down ~2.5% for the quarter., with short-term investment-grade credit down less than 2%.
  • On the bright side of the bond rout, higher rates means higher yields going forward. Short-term treasuries now yield ~4%, with junk bonds over 8%. Holding funds with bonds that mature soon means that those holdings are soon to be replaced by new bonds that pay today’s higher rates. Short-term losses are made up for quickly by higher yields going forward.
  • Interestingly, the ARK Innovation Fund (ARKK), which I’ve mentioned here in previous quarters due to it’s awful performance, did not make a new low for 2022 in Q3, despite the market as a whole doing just that. It’s still down 60% year-to-date though as the values of high-growth stocks have been destroyed by high interest rates.
  • Markets in general are still sharply up from the 2020 Covid lows and over the last 5 and 10 years. US Large and Small Caps have dominated global performance over the last decade.

The Inflation Reduction Act Of 2022

On August 16th, President Biden signed the Inflation Reduction Act of 2022 into law.  I’ll stay out of the debate on whether the Act will actually reduce inflation, but whether that’s true or not, the 273 pages of changes and additions to existing law will have some effect on many of our clients.  Many of the provisions of the Act impact corporations exclusively (including a new 15% minimum tax, and the new 1% excise tax on stock buybacks), so I’m going to leave them out of this summary.  The changes for individuals include the following:

1) Modifies the Non-Business Energy Property Credit (this is the credit for energy efficient windows, doors, roofs, etc.) starting in 2023 by extending it through 2032 and making it more robust:

  • The $500 lifetime limit is changed to a $1200 annual limit, though individual types of property have lower limits.
  • The rate increases from 10% of the cost to 30%.
  • Home energy audits (30% up to $150) are now included as eligible for the credit, as well as exterior doors (30% up to $250 per door, $500 total), windows (30% up to $600), insulation (30% up to $600), heat pumps (30% up to $2k, not capped by $1200 overall max), HVAC units /  water heaters / furnaces / boilers (30% up to $600), electrical panel upgrades to at least 200 amps as part of other energy efficient improvements (30% up to $600). 

Energystar.gov will have updated information on each credit by end of 2022.  That’s the most reliable site for ongoing energy credit information.

2) Extends the Residential Energy Efficient Property Credit (think solar panels on your roof) through 2034.  This 30% credit had started to phase out and was reduced to 26% for 2022, on its way to zero in the coming years.  Instead, 2022’s credit has been restored to 30% and that continues through 2032, phasing down to 26% in 2033 and 22% in 2034.

3) Replaces the old Qualified Plug-In Electric Vehicle credit ($7500 for qualifying electric vehicles but only for the first 200k vehicles sold by manufacturer) with the new Clean Vehicle Credit.  This new credit:

  • Runs from 2023 through 2032.
  • Remains capped at $7500 (lower, depending on vehicle sourcing and assembly).
  • Includes other alternative powered vehicles (e.g. hydrogen fuel cell)
  • Has income restrictions…  $150k single, $225k head-of-household, and $300k married filing jointly (though can use the lesser of the income in the year of purchase or the previous year to qualify).  These are cliffs meaning that if you are even $1 over the limit, you receive no credit.  It does not phase out slowly like most credits / deductions.
  • Has MSRP restrictions…  cars with MSRP over $55k and SUVs / light trucks over $80k are excluded.
  • Requires that final assembly of the vehicle occurred in the US and that a certain percentage of the minerals used to make the battery were sourced from North America or certain other countries that have trade agreements with the US.  These restrictions get tougher in later years (40% by 2024, 100% by 2029).
  • Does not have manufacturer sales caps (i.e. Tesla’s that meet the above requirements would qualify).
  • Allows purchasers to transfer their credit to the auto-maker starting in 2024 (means you get the credit as a discount off the purchase price, vs. having to pay full price and claim the credit on your taxes.  No details on how this will actually work.

For 2022, the old rules apply, except that the new assembly requirements are in effect as of the signing of the Inflation Reduction Act.  The Dept. of Energy has published a list of qualifying vehicles.  If you were in a contract for delivery prior to 8/16 and receive delivery prior to the end of 2022, a special transition rule allows you to treat the vehicle as delivered on 8/15 (i.e. no assembly requirements). 

The provisions of this credit are very complex.  The conclusion here is to check with the manufacturer before making the final decision on what kind of car you want to buy and assuming the credit will be available.  The sourcing / assembly restrictions, combined with the MSRP limits could make it tough for vehicles to qualify, especially early in the life of the credit.

4) Creates a new Previously Owned Clean Vehicle Credit that:

  • Runs from 2023 through 2032.
  • Is valued at the lesser of $4000 or 30% of the vehicle cost.
  • Applies to clean vehicles that are at least 2 years old.
  • Has income restrictions…  half those of the credit for new vehicles ($75k single, $112.5k head-of-household, and $150k married filing jointly (though can use the lesser of the income in the year of purchase or the previous year to qualify).  These are cliffs meaning that if you are even $1 over the limit, you receive no credit.  It does not phase out slowly like most credits / deductions.
  • Has vehicle value restrictions…  vehicles over $25k are excluded.
  • Has use restrictions…  Can only use the credit once every 3 years. The credit can also only be applied once per vehicle.

5) Creates the new High-Efficiency Electric Home Rebate Program.  This program provides qualifying low and middle-income families a total rebate of up $14k to purchase energy-efficient electric appliances.  This includes up to $8,000 to install heat pumps, $1,750 for a heat-pump water heater, $840 for a heat-pump clothes dryer or an electric stove, $1600 to insulate and seal a house, $2500 on improvements to electrical wiring, and $4000 toward upgrade of electrical panels.  The program will be administered by the states (states have to apply for their share of the $4.5B of Federal funding and there doesn’t seem to be any guarantee that all states will, or that their programs will exactly match those described above) and only those earning less than 1.5x the area’s median household income will qualify.  The rebate can’t exceed 50% of the cost of the project if the family income is between 80-150% of the area median income.

An additional, more generalized rebate program, also administered by the states is also available.  A retrofit that reduces a home’s energy use by at least 35% via insulation or other improvements is eligible for up to an $8k rebate, or 80% of the project cost, whichever is less.  For smaller projects that reduce usage by 20-35%, a $4k rebate is available.

6) Extends two ARPA provisions dealing with the ACA (“Obamacare”) through 2025.  As a result, those earning more than 400% of the Federal poverty line will still qualify for subsidies if their cost of purchasing a benchmark health insurance plan exceeds 8.5% of income.  Without this extension, in 2022, the income cap would have been $51,520 for an individual in most of the country, and $106,000 for a family of four.

7) Modifies Medicate Part D and Medicare Advantage Plans to:

  • cap monthly insulin costs at $35, starting in 2023.
  • eliminate additional out-of-pocket costs, starting in 2024, for enrollees who end up with enough covered prescription drug bills to qualify for catastrophic drug coverage.  This differs from today’s structure where enrollees still pay 5% of the bills even after they hit catastrophic coverage protections.
  • cap annual out-of-pocket drug costs at $2000, starting in 2025
  • allows Medicare to negotiate certain drug prices with manufacturers for the first time starting in 2026.

8) Increases funding for the IRS by $80 billion.  While this isn’t a provision directed at individuals, it’s possible it could impact you since a bigger IRS budget means more enforcement (i.e. audits), but, on the bright side, better taxpayer service.  Commissioner Rettig has written a letter describing what the IRS plans to do with the money, in case anyone wants his perspective.

Q2 2022 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), year-to-date, last 12 months, last five years, last ten years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (4/1/22-6/30/22)
Year-To-Date (1/1/22-6/30/22)
Last 12 Months (7/1/21-6/30/22)
Since Covid Low (3/23/20-6/30/22)
Last 5 Years (7/1/17-6/30/22)
Last 10 Years (7/1/12-6/30/22)

A few notes:

  • Q2 was an awful quarter for stocks across the board. Emerging markets performed best out of the major asset classes (-9%), with foreign developed (-14%), US REITs (-15%), US Large Cap (-16%), and US Small Cap (-17%) lagging behind. Continued interest rate hikes by the Federal Reserve to battle continued increases in inflation have pressured asset values and sparked fears of a sharp economic slowdown as a result. Whether we’re technically in a recession now (two consecutive quarters of negative GDP growth) or not, it’s clear that the Fed is determined to slow inflation at all costs right now, both by raising rates and via Quantitative Tightening (QT), or selling assets from their balance sheet.
  • Bonds had another tough quarter too in Q2. Long-term treasuries (TLT, not shown above) were down 13% in the quarter, now down 22% YTD as rates spiked, and prices (which are inversely correlated with rates) sank. We generally keep the bond side of client portfolios much shorter in duration, and include inflation-protected bonds, both of which faired much better again. Short-term inflation protected treasuries were only down 1.2% for the quarter., with short-term investment-grade credit down 1%.
  • Even commodities turned in negative performance for Q2. After being up as much as 11% for the quarter in early June, a sharp downturn across the board, and especially in energy delivered a -6% quarter.
  • The worst performing areas of the market in Q2 were the same as in Q1. The ARK Innovation ETF (ARKK), down almost 30% in Q1, tumbled another 40% in Q2, and is now down almost 75% from its 2021 peak. On the flip side, US value stocks are still holding up relatively well, down only 9% YTD vs. the S&P 500’s -20%.
  • Markets in general are still sharply up from the 2020 Covid lows and over the last 5 and 10 years. US Large and Small Caps have dominated global performance over the last decade.

Has Inflation Peaked?

As I’ve wrote back in May, inflation, leading to higher interest rates, leading to fear of a sharp economic slowdown, seems to be dominating stock/bond market performance of late (and not in a good way). I’ve been seeing some signs of inflation cooling of late and wanted to share a few, because you generally don’t get early/good signs of stuff like this on the news. Remember though, it’s very doubtful that overall prices will ever come back down to where they were. What’s were looking for is the increase in prices going forward to moderate back toward 2% per year. Below are some signs of actual price moderation, which would likely start to flow through the economy and ease the rate of growth of other prices. Has inflation peaked? No one has a crystal ball, but I’d say the below charts are a good sign for the short-term.

1) Baltic Dry Index – benchmark for the price of moving the major raw materials by sea. Moderating after the huge spike in late 2021.

Source: Trading Economics

2) US Natural Gas – a heavy input into the price of electricity in the US. Sharp decline from recent peak as exporting to Europe has been disrupted by facility issues.

Source: Trading Economics

3) Total Homes Currently For Sale – rising sharply after hitting all-time low levels that drove up prices over the last year. When combined with higher mortgage rates, this should slow down an overheated housing market.

4) Lumber – key input into new home construction costs, down over 60% from 2021 peak and more than 50% from winter 2022 just a few months ago.

Source: Nasdaq

5a) Gasoline Futures (RBOB) – we all know prices at the pump are a LOT higher over the past few months, but the price of gasoline futures is down pretty sharply from peak a few weeks ago. That takes a while to filter through the system since prices come down only a cent or two per day via competition between stations. But it’s a good sign. The current front month futures price of $3.55/gallon would generally translate to ~$4.35 national average at the pump.

Source: Nasdaq

5b) Gasoline Futures (RBOB) – In addition to the front month futures contract trending down, the shape of the futures curve is also down with Jan 2023 down to $2.70/gallon and Dec 2024 all the way down to $2.25.

Source: Chicago Mercantile Exchange

6) 5-year Breakeven Inflation Rate – by comparing the interest rate on Inflation Protected Treasuries (TIPS) vs. Non-Inflation-Protected Treasuries, we can estimate the inflation rate that the market has priced in over the next 5 years on average. After rising considerably (though still nowhere near the current 8%+ / year actual levels, the breakeven rate has fallen and is getting closer to the Fed’s comfort range ~2%.

Source: St. Louis Fed (FRED)

So maybe, just maybe, we’ve seen the worst, at least for the short-term. Much depends on both controllable factors like policy responses (hint: cutting the gas tax and handing out cash aren’t going to help increase supply or decrease demand) as well as non-controllable factors like the war in Ukraine. (global energy and food supplies this winter are going to be tight). Even if food/energy inflation stays high, if the “core” inflation moderates, it will give the Fed room to be a bit more dovish, and that’s likely to be taken positively by the financial markets.

Q1 2022 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), last year, last five years, last ten years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (1/1/22-3/31/22)
Last 12 Months (4/1/21-3/31/22)
Since Covid Low (3/23/20-3/31/22)
Last 5 Years (4/1/17-3/31/22)
Last 10 Years (4/1/12-3/31/22)

A few notes:

  • Q1 was the first down quarter for US stocks since the start of covid. All asset classes shown above except commodities, ended the quarter down between 3.8% (Short-term corporate bonds) and -6.5% (Emerging market stocks). Causes of the poor performance include the Russia/Ukraine war, spiking energy prices, high overall inflation, the Federal Reserve’s plan to raise interest rates over the next 2 years, and a re-emergence of covid in China, likely causing more supply chain disruptions. The bright side in all of that is the performance of commodities, which returned (in aggregate), over 28% for Q1. After being down and out since the financial crisis and pummeled again by covid, commodities have come roaring back over the last two years the top performer over that period.
  • Bonds had their worst quarter since the 1980s. Long-term treasuries (TLT, not shown above) were down 11% in the quarter as rates spiked, and prices (which are inversely correlated with rates) sank. We generally keep the bond side of client portfolios much shorter in duration, and include inflation-protected bonds, both of which faired much better. Short-term inflation protected treasuries were only down 0.4% for the quarter.
  • The worst performing areas of the market in Q1 were the high-flying US growth stocks with the ARK Innovation ETF (ARKK), down almost 30% for the quarter. On the flip side, US value stocks actually had a positive 1% return for the quarter. Higher interest rates are generally viewed as a headwind for growth stocks since much of their future earnings is far off in future years. The higher interest rates are, the higher the opportunity cost of investing in distant earnings rather than current earnings (more value-oriented). Growth has outperformed value for much of the last 15 years, which is a trend that may finally be reversing.

Q4 2021 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), last year, last five years, last ten years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (10/1/21-12/31/21)
Last Year (1/1/21-12/31/21)
Since Covid Low (3/23/20-12/31/21)
Last Five Years (1/1/17-12/31/21)
Last Ten Years (1/1/12-12/31/21)

A few notes:

  • Q4 was a very strong quarter (with a mid-quarter dip) for US Large Cap (+11%) and US Real Estate (+15%), but other asset classes fared substantially worse. US Small Caps still did well (+4%), but underperformed. Foreign stocks did worse with Developed Markets (+3%) and Emerging Markets (-0%) finishing down slightly on the quarter. US Bonds were flat to down 1% with Emerging Market Bonds down 3%. Commodities finished down ~2% after rallying strongly for the past two quarters.
  • For 2021 as a whole, the only truly poor performing asset class was Emerging Market Bonds (-10%) as the U.S. Dollar rallied and fears of a liquidity crunch in emerging markets dominated as the Fed begins to pull back on stimulus and even start raising rates in 2022. US significantly outperformed Foreign stocks as well. Real Estate (+41%) and Commodities (+29%) won the year as interest rates remained low as inflation spiked.
  • US Large Cap (S&P 500) has dominated over one, five, and ten years. The largest US stocks have performed best and gotten even larger, year after year. The top 2 companies in the S&P 500 (Apple and Microsoft), now make up 11.5% of the index. The top 10 make up 27.4% of the index. Diversified portfolios that include the other asset classes have underperformed as a result. Eventually though, this tide will reverse and smaller stocks will outperform larger ones. Foreign stocks, especially emerging markets, are about as cheap as they’ve ever been relative to the U.S. How long the dominance of a handful of US stocks can continue is anyone’s guess. But, the odds seem to favor a diversified portfolio outperforming the S&P 500 over the next few years.

Build Back Better Act, Property Taxes & Q4 Estimated Tax Payments

Rumor has it the Senate is ending session and heading home for the year tomorrow, and their version of the Build Back Better Act (see my last update for what’s included in the House version of the bill) hasn’t even been drafted, so it seems very very unlikely that anything will pass by end of year. That means at least a temporary end to Advance Child Tax payments, the expanded Earned Income Credit, and host of other pandemic-related programs. It also means no changes to retirement plans for now (i.e. the back-door Roth and mega-backdoor Roth remain), but those are definitely on the chopping block for a future bill. I don’t expect them to survive 2022. Lastly, it means that there won’t be a change to the 2021 State And Local Tax (SALT) deduction, again, for now. Build Back Better will re-emerge in 2022 for certain, perhaps with some provisions that are retroactive to 2021, though with a split Senate and a lack of support from at least two Democratic Senators, it’s a heavy lift to get BBB approved next year as well in it’s current form.

The fact that SALT won’t be changing for 2021 means that for those of you sitting on property tax bills for your residence or vacation home (rentals don’t matter…  property tax is always deductible on rentals) or determining if you should make state estimated tax payments for Q4, you should operate under the assumption that the SALT (State And Local Tax) cap will remain at $10K.  It’s possible that it could be retroactively changed in 2022 for 2021, but at that point, it will be too late to do anything for 2021 anyway.  That means that if both of the following are true:

  1. you already have $10K+ of state income taxes paid (check paystubs + estimated tax payments if you made any to cities/states to confirm) or sales tax paid in the case of a no income tax state (use IRS lookup for that https://www.irs.gov/credits-deductions/individuals/use-the-sales-tax-deduction-calculator) for calendar 2021  + property tax paid for calendar 2021 (check escrow statements if you escrow, otherwise you should know what you’ve paid) AND
  2. your 2022 will look similar to 2021 from an income/deductions/SALT standpoint…

… then there is no incentive for you to pay property taxes or state estimated tax payments in 2021 that could be deferred to 2022 (some municipalities allow this…  if yours doesn’t, then the point is moot for you). 

If you don’t already have $10K+ of SALT for 2021, then paying property taxes or state estimated tax payments in 2021 can still be beneficial if you will itemize your deductions on your taxes 2021.  To itemize, for most people, your SALT + mortgage interest + charitable deductions need to exceed the standard deduction ($12,550 single, $18,800 head-of-household, $25,100 married filing jointly).  If you can’t itemize in 2021, then deferring property taxes / state estimated tax payments to 2022 in hopes of being able to itemize then makes sense.

If you know you will not itemize in 2022 but will itemize in 2021, then you could pay property taxes and/or state estimated tax payments in 2021 even if you’re over the SALT limit.  The thinking there is that you wouldn’t be able to deduct those tax payments in 2022 no matter what, so if you pay them in 2021, it sets you up to take advantage of a retroactive SALT deduction increase if such a thing becomes law in 2022.

If you know that you will not itemize in 2021, but will in 2022, then defer property taxes / state estimated tax payments to 2022.

This fun game of “Will I get a tax deduction” is very likely to continue into 2022. We can only hope that the rules for 2021 are finalized in advance of the April 15th, tax deadline for 2021 and maybe, just maybe, the rules for 2022 could be settled before December 2022.

7.12% risk-free?!? Well, sort of…

There is no free lunch. I’m sure you’ve heard that statement before. As it relates to financial markets, it generally means that you can’t get an expected return above the risk-free rate without taking some level of risk. The higher the potential for return, the more risk must be embedded in the investment. Currently, there is somewhat of an exception, at least for the short-term, courtesy of the United States government.

Savings bonds are generally poor investments for the long-term. There are many types (“series”) of savings bonds and all but one are beyond the scope of this post. The exception, Series I Savings Bonds (“i-bonds”). These bonds are unique in that their variable interest rate is determined by a fixed rate, set by the Treasury at issuance (currently 0% and never below 0%) and a variable rate tied to the CPI (Consumer Price Index). The fixed rate portion is intended to reflect the “real” risk-free rate (i.e. net of inflation), with a 0% floor, while the variable portion is intended to reflect inflation. In this way, i-bonds pay an inflation-protected risk-free rate. Because of the current bout of inflation, the CPI increased by just over 3.5% in the last six months ending in September 2021. The variable portion of the i-bond rate is recalculated every six months based on the annualized change in CPI from the preceding six months. That means that i-bond rate for November 2021 through April 2022 is the 0% fixed rate + 7.12% variable rate = 7.12%. These bonds are backed by the full faith and credit of the U.S. Treasury, meaning they are about as default risk-free as can be and they’re currently paying 7.12%! So what’s the catch? There’s no free lunch right? No catches per se, but there are some things to be aware of…

First of all, that 7.12% is variable and will reset in May of 2022 based on the change in CPI between November 2021 and April 2022. For each six-month period of time, you’ll receive the variable interest rate, which is not known in advance. It’s unlikely to stay anywhere near 7% over the long-term unless inflation persists. Even then, your return will always only equal inflation. In normal times, that’s not much of a goal, but in a world of negative real interest rates, keeping up with inflation alone may appeal to at least some investors. While it’s unlikely to beat equity investments over the long-term, it’s certainly better than a savings account at one of the major banks paying 0.01%. But there are a few more disadvantages here…

Second, you are required to hold i-bonds for a full year from purchase. I know what you’re thinking… there’s always a way around requirements like that (CD’s charge some interest penalty for example, or illiquid investments that can be sold at below-market prices in case of emergency). Unfortunately, there is no work-around in this case. One full year holding period is required and there is no way to liquidate during that time. Beyond the one-year holding requirement, you can liquidate at any time, but, if you liquidate during the first five years, you are charged a three-month interest penalty (e.g. if you hold for 18 months, you only get the interest for the first 15 of those months). Once you’re past five years, the bond becomes fully liquid with no penalty, and you can hold it for up to 30 years when it will mature and stop paying interest.

Third, you can only purchase $10k of i-bonds per entity per year. What does “per entity” means? It generally means per person, but if you have a business or a trust, those entities can purchase $10k per year as well. So there’s no way to park hundreds of thousands of dollars in i-bonds for the short-term while they’re paying this rate and then liquidate them if rates fall over the next few periods.

Fourth, because i-bonds pay interest rather than qualified dividends or capital gains, that interest is taxed as ordinary income taxed at your highest marginal tax rate (meaning your after-tax return is going to be well less than the rate of inflation). On the plus side though, that interest is deferred until the year you cash in the bonds, so you can choose an otherwise low-income year to keep the marginal tax rate down. Also, as an obligation of the federal government, they are state income tax free, which makes them a bit more appealing if you live in a high income tax state.

So, what’s the bottom line? Should you run out and buy $10k of i-bonds as soon as possible? Well, they’re not a great long-term investment, paying a guaranteed after-tax rate that is less than inflation. They’re not a good emergency fund given the one-year holding requirement. But, right now, in a negative real risk-free rate environment, the fact that the fixed rate portion of the bond cannot go below 0% makes them appealing for those who have significant savings in cash, beyond an emergency fund and other liquid assets. If you’re the type of investor who likes to have a surplus of cash, beyond what you’d need over the course of a year in the case of an emergency like a job loss or disability, this can be a good place to park $10k ($20k if married, $40k if married with trusts, $60k if married with trust and two businesses). It can also be a good replacement for part of the (especially short and/or inflation-protected) bond portion of an asset allocation, since it’s going to pay a higher rate of return, at least for now.

If you decide that i-bonds are for you, you can’t purchase them or hold them in a bank or brokerage account and your financial advisor can’t buy them for you. You’ll need to go to www.treasurydirect.gov and buy them directly from the US Treasury. Opening an account is fairly straight forward and you can link a bank account quickly which will allow you to schedule a purchase right away. If your information is mismatched with something in the Treasury databases, you may have to mail in a form with a Signature Guarantee (like a notarization, but obtained from a bank) to prove your identity. This is also likely if you open an account for a Trust or a business. Once the account is opened an a purchase is made, you’ll see interest being credited after the first three months you hold the bond (that’s the three-month penalty you’d incur if you sell in the first five years). You can track the bond values over time as they accrue interest and can purchase more in future years as desired. Just remember, you’ll always earn the fixed rate that was in place when you purchased the bond (currently 0%) + the variable rate for each six-month period going forward.

You can find more details about i-bonds at the Treasury’s FAQ page for i-bonds.

Special 2021 Deduction For Non-Itemizers Giving To Charity

Giving Tuesday is coming up at the end of November, so here’s a special reminder about this year’s “bonus” charitable deduction. As part of the CARES Act in 2020, Congress authorized a special charitable deduction for 2020 only for people who aren’t able to itemize due to the standard deduction being higher than their itemized deductions. The limit was $300, and that was the case whether Single, Head-Of-Household, or Married Filing Jointly. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, passed late last year extended this deduction into 2021 and doubles it to $600 for joint filers.

As with last year, to qualify, the donation must be in cash, it must be to a qualifying organization (which is the same as for charitable donations as itemized deductions), it must be made by 12/31 (2021 this year), and appropriate records must be kept. As with itemized deductions, you can check whether the organization qualifies using the IRS’s Tax Exempt Organization Search. A $300 or $600 deduction may not sound like a lot, but many people have already made, or are about to make, some cash contributions for friends, colleagues, or family members that are raising money for various organizations. If you’re going to make the contribution regardless of the tax benefit, you might as well take the tax benefits that are available. In most cases, substantiation simply requires an acknowledgement from the organization (including stating that you received no benefits for your donation) and a cancelled check or credit card statement. (For detailed record keeping requirements and special cases, see Charitable Contributions – Deductions & Recordkeeping in the blog archives.) So save those “thanks for your contribution” acknowledgement emails and keep a running list of your cash donations this year, whether you itemize or not. They will come in handy to the tune of up to $300 or $600 in deductions at tax prep time.

Updates on Infrastructure & Build Back Better

As many of you know, the Infrastructure bill passed the House last week in a late night Friday vote. It had already been passed by the Senate and now waits for President Biden to sign it into law. He’s scheduled to do that via a public signing ceremony on Monday, 11/15. Not much was included in that bill from a tax or personal finance perspective (tighter cryptocurrency reporting requirements was the biggie), so I won’t dive into the details. The full text, all 1,039 pages of it, can be found at the link above.

Next up on legislators’ plates are the Build Back Better Act, funding the government, and an increase or suspension of the debt limit. The Build Back Better Act is the latest iteration of the broader social spending plan and tax changes that I discussed back in September (here and here). Many of those provisions have changed. While they’re nowhere near set in stone at this point, I wanted to provide an update of what’s currently in and what’s currently out (hint: a lot more is out than is in). Full text of BBB as of 11/3/21 can be found here.

  • Higher income tax rates – original plan was to increase the top rate from 37% to 39.6% and compress the tax brackets so that the top brackets begin at $400K Single / $450K Joint. This has been eliminated. If that stands, that means no need to accelerate any income into 2021 from 2022.
  • Net Investment Income Tax (NIIT) changes – subjects pass through active income to the 3.8% NIIT. This is still included and basically means that businesses that became S-Corps to try to avoid paying FICA on the “profits” vs the salary, will now have to pay NIIT on those profits instead.
  • Earned Income Credit (EIC) enhancements – remain
  • Surtax on millionaire income – The 3% surtax on incomes over $5M has been changed to a 5% tax on incomes over $10M and and additional 3% on incomes over $25M.
  • Higher capital gains tax rate – This has been eliminated. This means no need to intentionally realize capital gains to lock in today’s lower tax rate.
  • Change in corporate tax rate – The reduction in rate for small business and the increase in rate for all other business has been eliminated. But, a new 15% corporate alternative minimum tax on large corporations is included and a new 1% tax on corporate stock buybacks is added.
  • Changes to 199A Qualified Business Income (20% small business deduction) – This has been eliminated. All the complexity and current income caps would remain as-is.
  • IRA / Roth IRA restrictions – these have remained though some have been delayed and one has been removed:
    • Contributions to IRAs wouldn’t be allowed if the value of all your IRAs exceeds $10M and income exceeds $400k for the year.
    • RMDs would be required for IRAs/Roths over $10M.
    • The conversion of after-tax dollars from a Traditional IRA / 401k / 403b / etc, would be prohibited, effectively eliminating the Backdoor Roth and Mega-Backdoor Roth strategies. This would begin 1/1/22, which means the end of 2021 is the last chance to use these strategies. It may make sense for those who usually make IRA contributions at tax time for the previous year and then convert to their Roth (“backdoor Roth”) to do this by 12/31/21. It may also make sense to convert IRAs that have after-tax dollars mixed with pre-tax dollars even though this will generate some income in 2021 as it would be the last time to convert the after-tax portion.
    • All Roth Conversions would be prohibited for high income taxpayers after 2031 (this one is a funding gimmick that would pull forward conversions into the 10-year period over which the bill is analyzed to determine its net cost).
    • The restriction on private investments and those that could only be made by “accredited investors” has been eliminated in the latest bill.
  • Reduction in the gift/estate tax exemption – This has been eliminated, meaning the currently scheduled reduction in 2026 remains. No need to scramble and try to gift away tens of millions of dollars in advance of a 2022 change.
  • Changes to grantor trusts to pull them back into the estate of the grantor – This has been eliminated.
  • SALT (state and local tax deduction) – the current $10k limit on deductions was unaltered in the original proposal. The new bill increases the deduction cap to $72,500, but also extends the cap which would have expired in 2025, to 2031. If this goes through, anyone who can delay property tax payments or state estimated tax payments to 2022 would be better of doing that than paying in 2021.
  • Expanded Energy Tax Credits – still included
  • Expanded Plug-In Electric Vehicle Credits – still included
  • Extension of the 2021 enhanced child tax credit – still included
  • Universal Pre-K – still included
  • Credit for other dependents – eliminated
  • Extension and permanence of the 2021 Dependent Care Credit – eliminated
  • Caregiver’s credit – eliminated
  • Paid family and medical leave – still out.
  • Free community college – never made it in
  • Elimination of basis “step up” at death – still not included.
  • Elimination of the ability to borrow tax-free by pledging a securities portfolio – still not included
  • Changes to the taxation of “carried interest” – still not included.
  • “Billionaire’s Tax” – tax on unrealized capital gains of billionaires – still out
  • Medicare dental and vision – never made it in
  • Lower prescription drug prices – never made it in (though there’s talk of brining this back in the Senate)

Remember, all of this is in a high state of flux and nothing is certain at this point. The Senate is likely to produce its own version of Build Back Better and then the House and Senate versions need to be reconciled, voted on again, and signed by the president. Given the differences between the progressive and moderate sides of the Democratic party and the wholesale opposition by the Republican party, the odds of anything getting passed into law by the end of 2021 feel lower than 50%. In fact, current prediction markets are pricing the following for a law that passes by the end of 2021:

  • a 30% chance that income taxes increase in any way (including the currently proposed surtax on millionaires),
  • a 33% chance that the SALT deduction will be modified,
  • a 13% chance of a “billionaire’s tax”
  • a 10% chance of an increase in capital gains.
  • a 6% chance of a corporate tax rate increase.

Not very promising odds, but that doesn’t mean that nothing will pass. It also doesn’t mean that the whole thing isn’t punted into 2022 and passed then.