“Silver lining” strategies to add value during a market disruption: 1. Roth IRA conversion, 2. tax-loss harvesting, and 3. rebalancing.

Silver Linings Playbook

The global pandemic has caused massive disruption in the financial, healthcare, and employment markets over the past several months. It seems you can’t go more than a few hours without hearing about all the damage this virus is causing. We thought we would point out some of the possible opportunities, or “silver linings,” we see in our little corner of the world. We are considering some strategies for clients that may add value to their lives over the next several years. These include a Roth IRA conversion, tax-loss harvesting, and rebalancing.

1. Roth IRA conversions

A Roth IRA conversion is when you transfer all or a portion of your Traditional IRA to a Roth IRA. The amount converted is taxable in the current year, but all the money transferred into the Roth IRA will grow tax-free for the rest of your life. One of the largest determinants of whether it is a good time to convert your IRA (or a portion of it) to a Roth IRA is the tax bracket you are in now versus the tax bracket you will be in you are withdrawing the money (typically in retirement). If it is lower (or even the same) today as it will be at the time of withdrawal, it is typically a good time to convert.

Three reasons why 2020 an interesting time to consider a Roth IRA conversion:

  1. First, if any of your income relies on economic activity (perhaps you own a business, or you receive bonuses for sales performance), you will most likely see a drop in income. That may create an opportunity for you to be in a low tax bracket in 2020 (one of the factors that should be present if you plan to convert).
  2. Second, there is a decent chance that tax laws could change in the future, causing income tax rates to rise. Government debt has ballooned, and there is a chance that Congress will look to raise revenue by altering tax rates. The current tax law sunsets in 2026, causing income tax rates to rise unless Congress and the President can pass legislation to alter the tax code.
  3. Third, asset values have dropped, causing the potential for higher future returns.  Typically, there is recovery after a market crash.  It is much more advantageous to experience higher returns in a vehicle that will not require you to pay tax on those gains (like a Roth IRA). For all those reasons, it is wise to run detailed tax projections to understand if this strategy could make sense for you.

2. Capital loss harvesting

Losses in the capital markets have been swift. In assets that are easily swapped with other like-kind investments (for example, sell an international stock fund and use the proceeds to buy a similar international stock fund), you can realize a capital loss for tax purposes. Plus, you keep the same exposure to the asset class. Those losses can be used to offset ordinary income (maximum of $3,000 per year) or capital gains either this year or in the future. If you have losses in your portfolio and plan on selling other assets in the future that have embedded capital gains (like a business or investment real estate property), this is a great time to harvest those losses for future use.

3. Capital gain harvesting

It may be strange to have opposite strategies in the same article but depending on your situation, harvesting capital gains could be advantageous. For those in very low-income tax brackets (married filing jointly with taxable income under $80,250), capital gains are taxed at 0%.  It could make sense to sell appreciated securities if your federal tax rate on those gains is 0%. You may not want to sell your Amazon or Apple stock that’s up 500%. That’s ok; you really don’t have to. Let’s say I own $25,000 of Amazon that I paid $5,000 for.  I could sell that position, recognize a $20,000 gain, and immediately repurchase those same Amazon shares.

By doing so, I would recognize a $20,000 gain (which is taxed at 0%), AND I would reset my cost basis to $25,000, lowering my future tax liability (since I no longer will have to pay capital gains on that $20,000).  We have seen this strategy work for business owners who have large operating losses and are therefore in very low-income tax brackets or retirees who have yet to collect Social Security or retirement plan distributions.

4. Rebalancing portfolios

One of the simplest strategies to consider during this time is to rebalance your portfolio back to its target weightings. This may seem simple, and you may have heard it before, but we’ve found that without a disciplined strategy on how you will execute, it is one of the hardest things to do. The reason? Because you have to sell assets that are going up and buy assets that are going down. Think about the depths of the market during this crisis. Did you really want to buy stocks, even if your equity allocation was slightly off target?

We’ve found most investors tend to freeze in the face of such carnage. Very few people are willing to run into a burning building. It’s not too late. While you may have missed the bottom of the market, recommitting yourself to a disciplined process versus following the headlines remains the best way to manage a portfolio.

We recognize that everything is not ok. Millions of people have lost their jobs, thousands worldwide have died, and the social toll this virus has taken is hard to measure. But progress does not standstill. Researchers are working on new treatments and vaccines; new companies are being born, and strategies to stay connected to each other continue to evolve. Your personal finances should not be any different. There are opportunities for progress if you look hard enough.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.

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