Asset prices are significantly down from recent highs. The bear market is here, and we have no idea how long it will be before the bulls are back on top. While looking at retirement or other investment account statements may not be the gratifying experience it was in 2021, there are things investors can do to take advantage of the drop in asset prices. These moves can help set your portfolio up to recover and reduce tax liability. In some cases, the savings on taxes may have knock-on effects that make up for the temporary decrease in value.
Reap the Tax-Loss Harvest
The current market presents an opportunity to sell depreciated assets and use the loss to offset the capital gains taxes on assets that have appreciated since. This is particularly effective in offsetting capital gains on equities that you own at a low basis or have held for some time. And given the long bull market and the performance last year – you probably have some of these in your account.
Even if you don’t have offsetting capital gains, tax-loss harvesting can still make sense. You can use up to $3,000 of losses to offset your current ordinary income. You can also carry the loss forward, offsetting $3,000 annually until the amount of the loss is exhausted.
Rebalance Your Portfolio
Identifying stocks you intend to sell is a good impetus for an overall portfolio rebalance. Review your short- and long-term goals to be sure that your investment plan doesn’t need tweaking. Once you’ve determined the right strategy, you can sell assets to nudge your portfolio back in line with your preferred risk parameters and market views. Adding diversification can help to cushion your portfolio, and there may be assets that represent better value or growth potential now that prices have declined.
Don’t Neglect Savings
Investing when asset prices are lower makes sense, particularly if you have a long-term perspective. Investing into a down market (that may go lower) doesn’t feel great, but comparatively, stocks are “on sale” from recent highs, and we know from history that the market does go higher over time.
The other advantage to putting away tax-advantaged savings is lowering your taxes during your working years. Investing the maximum in your 401(k) account, putting away funds in a Health Savings Account, and creating tax-free growth in a 529 Plan for education savings (and potential state tax benefits) are ways to lower your tax burden now, as well as position your portfolio to benefit from a recovery.
The Roth Conversion Is More Attractive
Retirement tax planning is critical to keeping as much of your income as possible. You not only want to stay in lower tax brackets, but you also want to avoid having an income level that will result in taxes on social security or the imposition of the IRMAA surcharge on Medicare Part B and Part D premiums.
Tax-deferred retirement savings are important in your accumulation years, as they lower taxable income. But you reverse the process when you make withdrawals in retirement. And starting at age 72, required minimum distributions (RMDs) will limit your income flexibility.
One solution is a Roth conversion, in which you withdraw from your tax-deferred account, pay the tax and invest in a Roth account. There are no income limits on conversions, but the withdrawals are taxed as ordinary income. Lower asset prices mean you’re paying less in taxes. As asset prices recover, growth will be tax-free, and future withdrawals will be tax-free. And because you’ve already paid the tax, RMDs are not imposed.
The Bottom Line
After a long bull market, getting used to the new reality of volatility and lower asset prices can be difficult. But changing your perspective to proactively look for ways to make the most of our new bruin reality can help you ride out the discomfort more effectively and help keep your plan on track.
If you’d like an objective second opinion about your finances, please contact Michael Shea, a CERTIFIED FINANCIAL PLANNER™ and owner of True Equity Wealth Management LLC. Email him at [email protected] or fill out a contact form.
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