We’re all going through a situation with no precedent right now, and it can feel challenging to take any action. But, we believe that there are some important tax strategies that can help you navigate during these challenging times that may not only help you weather the current storm but set you up for success down the road.
One strategy we recommend for our clients is tax-loss harvesting, which involves selling an investment that has lost value, replacing it with similar investment, and then using the investment sold at a loss to offset any realized gains. This can help investors minimize any taxes they may owe on capital gains or their regular income. It can also improve overall investment returns. This strategy, however, can only be applied to taxable investment accounts, including retirement accounts like IRAs and 401(k).
Another strategy can be a Roth conversion. Converting retirement savings from pre-tax to Roth accounts has become less expensive for many investors because of the recent stock market selloff. According to CNBC a single taxpayer with a $1 million IRA would have paid about $41,000 less in tax to do a conversion after the market downturn than before it. However, it can be complicated, and may not be the right strategy for everyone. We recommend you take a hard look at your portfolio and your financial goals and then speak with a professional to help decide if this strategy is right for you.
Keep in mind that this conversion means that savers would opt to pay income tax now, while markets are down and tax rates are lower under the Tax Cuts and Jobs Act, but you shouldn’t base Roth conversions only on market moves. Essentially, it’s like trying to time the market, which is notoriously difficult, even for experienced portfolio managers.
Having Roth funds is beneficial for several reasons. Retirees don’t have to take mandatory withdrawals from Roth accounts, unlike traditional IRA accounts which require withdrawals once you reach 72 years old. Taking Roth distributions could also help decrease Social Security taxes & Medicare premiums, which are pegged to one’s taxable income. Lastly, there’s the benefit of tax diversification is important because it reduces the risk associated with unknown future tax rates.
A final strategy revolves around maximizing your income and minimizing your taxes. For example, let us look at a couple who are over 65. If they take a standard deduction for 2020, have $30,000 in municipal bonds, $28,000 in Social Security Income, and have $80,000 of capital gains, they pay no federal tax on $138,000 in income. This is made possible through the coordination of tax deductions, Social Security, municipal, and other income so that you can still maximize income, but minimize taxes. While everyone’s situation is different, there may be a formula that we can offer to help you achieve similar results.
These are just a few of many tax strategies you can consider when markets are volatile. But, all of these are complex and require knowledge and experience. We strongly recommend that you work with an experienced advisor to help with any of these strategies to reduce the chance of making costly mistakes.