Tax Planning Strategies During Market Declines

Market volatility can provide plenty of opportunities for portfolio rebalancing and this is especially true when markets enter “correction mode”. Market corrections are associated with price declines of 20% or more. As many of you know, we are actively monitoring investment portfolios for rebalancing opportunities to take advantage of market corrections. In addition to portfolio rebalancing, there are several tax strategies that can provide additional long-term benefits. Below is a list of proactive tax strategies that we think are worth exploring to take advantage of the current market environment.

Tax Loss Harvesting:

How it Works: When positions drop in value below your cost, it is worth considering selling the fund/stock to book the tax-loss. We recommend simultaneously purchasing a proxy-position to make sure you do not miss out on any market recovery. The IRS has very strict rules regarding tax loss harvesting – specifically, the IRS does not allow us to repurchase the same security within a 30-day window. If this period is violated the tax treatment for the capital loss changes and becomes less advantageous.

Planning Tip: We are actively reviewing your Coldstream Managed portfolio for opportunities to tax loss harvest meaningful losses.

Benefit:

• A means of improving after-tax return on taxable investments.
• Tax losses can be used to offset future capital gains. If you do not have capital losses to offset, you can use up to $3,000 per year to offset ordinary income. These losses can also be used to offset gains from real estate sales or gains from selling a business.

Reducing Concentrated Stock Positions:

How it Works: When positions drop in value, consider reducing exposure to concentrated stock positions and reinvesting in the broader market. This strategy can be combined with the tax loss harvesting strategy above. Specifically, you can harvest losses in other strategies and use those losses to offset gains in your concentrated position.

Planning Tip: We encourage strategies to reduce concentrated equity as part of your long-term plan. Having a plan in place helps to remove some of the emotion that can come from diversifying a concentrated stock position.

Benefit:

• Diversification helps to reduce company specific risk in your portfolio.

Roth IRA Conversions:

How it Works: Roth IRA Conversions involve converting funds from your Traditional IRA to your Roth IRA. You may incur taxes on the conversion, but this is an advantageous strategy if you are able to convert at a low tax rate because the funds will grow tax-free. When markets have declined in value it provides additional benefit because you are able to convert more shares. Then once the markets recover, the converted shares will recover in a tax-free vehicle.

Planning Tip: It is important to work closely with your Advisor and CPA to target a specific dollar amount to convert from year-to-year. The Tax-Cut-And-Jobs Act eliminated the ability to recharacterize (essentially undo) Roth Conversions so it is important to convert the correct amount. We work closely with you and your CPA to determine the optimal amount and make sure you do not convert at too high a tax rate.

Benefit:

• Tax-free growth
• Be aware, the SECURE Act, which passed at the end of 2019 changed how IRAs and Roth IRAs pass to beneficiaries. Under new rules, IRAs and Roth IRAs must be distributed to non-spouse beneficiaries within 10 years. Roth IRAs will still be able to pass tax-free, so this is an advantageous estate planning strategy.

Retirement Contributions:

How it Works: If you have not already funded your IRA, Roth IRA, and/or Self-Employed 401(k), considering contributing to your retirement account when markets are experiencing a decline. Funding when markets are down gives you an opportunity to invest your funds at an advantageous price point and then experience the market recovery in a tax-advantaged account.

Benefit:

• Helps meet annual savings goals.
• Investing during market declines can lead to improved performance over time.

After-Tax 401(k) Contributions:

How it Works: Some company 401(k) plans allow for after-tax contributions up to the annual max allowable by the IRS. If your plan allows for after-tax contributions, consider making this contribution and then transferring the funds to your Roth IRA.

Planning Tip: If your 401(k) Plan allows for after-tax contributions, we can discuss how to best take advantage of this benefit. If you are unsure if this benefit is available in your current plan, reach out to your Coldstream team to discuss what information would be helpful in researching this benefit.

Benefit:

• Tax-free growth
• Helps meet annual savings goals.

Family Gifting:

How it Works: For those who are using the annual exclusion to make gifts to other family members, this is an opportune time to make these transfers as gifts can be used to reinvest in the stock market while it is at lower values. It’s also a fantastic time to start Roth IRAs for young adults who have employment income. If your larger estate plan includes the use of trusts, the market downturn creates an opportunity to fund those trusts with assets that have depreciated in value and capture the upside within the trust structure.

Planning Tip: If you are annually gifting or considering larger gifts, reach out to your Coldstream team to coordinate a discussion with your estate planning attorney and CPA. We can explore the strategies that would best meet your family goals and help execute these gifts during the market downturn.

Benefit:

• Reduction in future estate tax.
• Helps young adults start investing and take advantage of market declines.

Tax planning is an important part of every investor’s long-term plan and we are here to help you explore various options. If you have specific questions or would like to understand if you can benefit from any of these tax strategies, reach out to your Coldstream team. We look forward to working with you and your CPA to understand what options may be available to you.