There is no doubt that our country, and our world, are facing some very serious challenges ahead. Inflation is high, there is fear of recession, and we are divided as a nation. However, there are opportunities that present themselves to us during this time that could place us in a better financial situation in the future. What are those opportunities and do they make sense for you?
The first assessment you need to make is whether you have some income security. Will you have enough money coming in to cover your bills? Do you have adequate savings to get you through these tough times? If the answer is yes, then you can start looking for opportunities where they exist.
1) Roth conversions. Many people have traditional IRA accounts vs Roth IRA accounts. A good description of the differences are here. The short version is that with a traditional IRA you have put the money in pre-tax. You likely received a tax deduction in the year you contributed the money, the money grows tax deferred and when you take out the money, you will be taxed on 100% of it at withdrawal (there could be a penalty for withdrawals before the age of 59 1/2). With a Roth IRA, you do not get the tax deduction at contribution, but all of the money you withdraw in the future will come out income tax-free (you must meet a 5-year holding period and there could be a 10% penalty on pre 59 1/2 withdrawals). You are limited to how much you can contribute on an annual basis to both plans and with the Roth, there are income limitations that reduce or disqualify you if you make too much money.
In a down market, when you expect that the market will recover, it can be an optimum time to convert an IRA to a Roth. To convert, you pay taxes on the fair market value of the taxable portion of the IRA. If you have an IRA invested in XYZ ETF, which is down 30% and convert to a Roth, you pay taxes on the fair value. If it recovers, you will have made the gain tax-free.
There is also the tax bracket consideration for a Roth conversion. If your income is down as well, you can pay taxes at a tax rate lower than you normally are in. There is also the risk that tax rates will move higher in the future. If tax rates go up across the board in the future, it would have benefited you to pay taxes at the lower rates of today.
Conversions can be a tricky maneuver, and I highly recommend talking to your financial and/or accounting professional before making any conversions.
2) Keep to your long-term investment plan. If you are contributing to your 401(k), 403(b), 457, IRA etc. plans, keep doing it. The temptation is to reduce contributions during times of uncertainty.
If you believe the stock market will rebound, which many do, keep buying. My wife and I have continued the funding of our plans. We are purchasing many assets at 20-30% below what we were buying them a year ago. If the market goes down another 20%, we will still be buying.
It is totally reasonable to reduce contributions IF you need the cash flow. If you do not need it, then continue your contributions. It might even make sense to increase the contributions, depending on your own personal situation.
3) Tax loss harvesting. If your investments are down you may be able to sell them and deduct the loss, up to $3000 for married filing jointly, from your income tax. Be careful of wash sale rules, which means you can’t sell and buy back the same stock/ETF within 30 days. You will also need to keep track of cost basis. The following are important notes pertaining to tax loss harvesting.
It applies only to investments held in taxable accounts
It’s not as financially fruitful if you’re in a low tax bracket
Tax-loss harvesting is most useful if you’re investing in individual stocks, actively managed funds and/or exchange-traded funds
You must keep long term capital gains (investments bought and held longer than 12 months) and short-term capital gains (investments bought and sold in less than 12 months) straight
The deduction for losses is limited to $1,500 to $3,000 a year, depending on individual or joint filing. You can carry losses forward to future years.
Don’t sell your losers just to get the tax break. If it doesn’t make sense to sell for your long-term plans, don’t sell. Don’t let the tail wag the dog here.
Put the cash from the sale to good use. Use it to rebalance your portfolio, give yourself some different exposure etc.
As you see, tax loss harvesting is not the easiest thing to undertake, so I recommend working with a qualified tax-professional when executing this strategy.
The past several months have been trying on everyone. It’s human to have felt it, and it’s something we should all be comfortable talking about. During all this, we must do our best to not let the anxiety or sense of panic overcome us and remain calm.
It is with this sense of calm that we can remain clear-eyed and see the opportunities that may present themselves to us. We will get through this together. When we do, I want you to be in the best position possible to reach all your goals, dreams, and desires.
Securities offered through The O.N. Equity Sales Company, Member FINRA/SIPC, One Financial Way, Cincinnati, Ohio 45242 (513) 794-6794. Investment Advisory Services offered through O.N. Investment Management Company.
Please consult with your tax professional for additional guidance regarding tax-related matters specific to your individual situation.