I had that turned off on iPadOS 14 as well. I think if you have it turned on the little thing there can accommodate having the quicktype suggestions and just grows to fit.
But why would you want that when you have a physical keyboard attached? It's faster to just type the word than to reach up and tap. And same with bold/italic. cmd+b/cmd+I is faster and more comfortable. Though again, if the app had them before the little thing can have them too- Screenshot I showed was from a text field without extra options. It had more on it in Notes for example