Tax season may officially end in April, but tax planning is an evergreen process. There are ways to optimize your tax strategy regardless of the prevailing investment environment, including when market volatility spikes and investments decline in value. Below, we highlight a few tax planning strategies to consider in challenging market environments.
Roth conversions: tax impact today for lower future burden.
Roth conversions provide an opportunity to realize the tax impacts of a retirement account withdrawal when portfolio values are down and reduce the overall tax impact over the long term.
Roth IRAs are funded with post-tax dollars. This means that your earnings and withdrawals are tax-free, as long as you have had your account for at least five years and don’t start taking money out until you are at least 59 ½ years old. But you may have money in other accounts, such as traditional IRAs or 401(k)s. These accounts are funded with pre-tax dollars, which means you pay taxes at the time of withdrawal.
It may make sense to convert from a traditional IRA or 401(k) to a Roth IRA for a number of reasons. For example, you may expect to be in a higher tax bracket when withdrawing the funds in the future. Or you may view a decline in portfolio value as an opportune time to realize the tax hit today, assuming that your portfolio value will increase—and therefore carry a higher tax burden—over the long term. (Before taking any action, it is critical to consult with your advisor(s) to ensure you develop a plan that is right for your unique situation.)
Required minimum distributions (RMDs) are another reason to consider converting your traditional IRA and 401(k) to a Roth IRA. Once you turn 72, you will be required to take withdrawals from your traditional IRA and 401(k). If these taxable accounts are large, RMDs can be sizable and possibly push you into a higher tax bracket. But there are no RMDs for a Roth IRA during your lifetime.
Other tax-smart strategies to consider today.
In addition to Roth IRA conversions, there are other tax strategies that may be beneficial in a down market environment.
Tax-loss harvesting: If you own investments that have declined in value, you can consider selling them and using the losses to offset capital gains. If you have more losses than gains, you can use up to $3,000 in losses per year to offset ordinary income on your federal taxes, and you can carry over any unused capital losses to future years. It is important to be mindful of the IRS’s “wash sale” rule, which prohibits you from claiming the losses if you purchase a near-identical investment within 30 days of selling the original investment.
Gifting: When financial markets are up, you may want to gift appreciated stock to qualifying charities to limit capital gains taxes. But when markets are down, you may want to consider increasing gifts to your family. Depressed values allow you to transfer more shares of stock than you could when values are up, essentially giving you more “bang for your buck” in terms of your lifetime gifting limits. This year, the annual gift tax exclusion is $16,000 per person, up from $15,000, where it had been since 2018.
Increasing retirement plan contributions: Similarly, when security prices are down, your regular contributions to retirement plans—such as your IRA and 401(k)—will buy more shares of stock within these plans than when prices are high. So, if you aren’t already maximizing your contributions to these plans, you may want to boost your contributions.
Exploring advanced trust strategies: The federal estate tax exemption is now $12.06 million, up from $11.7 million in 2021. But unless the laws governing estate taxes change, the estate and lifetime gift tax exemption amount will revert to approximately $6 million (adjusted for inflation) in 2026. This “sunset” provision may affect your gifting and estate planning strategies, and now is a good time to begin working with your advisor to plan for these changes.
Make the most of a challenging environment.
Market volatility can be unsettling. But it also provides opportunities to make some tax-smart moves. At Leelyn Smith, we can help you make the most of a difficult investment environment. Please contact your advisor to learn more.
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This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.