Updated: May 18

Here we are in very turbulent times in the stock market. For long-term investors, it is best to stay the course because, as history tells us, the market rewards long-term investors. I do not advocate timing the market as an investment strategy or trading frequently. However, there are some adjustments that an investor could pursue in these volatile times:

  1. Sell positions on investments that have been losing value over the past 3-5-10 year period.

  2. Purchase stocks of solid companies that meet your criteria for long-term investment

  3. Rebalance the portfolio to match your risk tolerance i.e. move towards defensive position or reduce concentrated holdings

Net Losses are deductible from Ordinary Income

One side effect of selling losers and rebalancing your portfolio is that you may incur losses that can offset gains from selling other positions. Besides, if you have a total net loss (total losses more than gains) in a year, the tax law allows you to deduct up to $3,000 (married filing jointly) or $1,500 (single filer) of net loss from your ordinary income. And if the losses are more that $3,000, you are allowed to carry forward the losses to the subsequent years. For example, you dumped some bad performing funds for a loss of $15,000 and sold some other funds for a gain of $8,000. The net loss of $7,000 ($8,000 - $15,000) will offset this year's income by $3,000, reducing your taxes by $660 assuming 22% marginal tax bracket. The remaining $4,000 ($7,000 - $3,000) in losses can offset any capital gains in the next year or carried forward.

Tax-Loss Harvesting Strategy

Interestingly, the capital gains and losses can be from any sale, including real property. This method of using losses systematically against gains is called "tax-loss harvesting". This strategy is used by many high-income earners to take profits and sell losers in their portfolio to improve their after-tax return every year, However, there are important caveats as to what kind of losses are permissible. Of course, this strategy works only in taxable accounts and not in tax-deferred accounts. Newer robo-advisor platforms, like Betterment or Wealthfront, claim to use regular tax-loss harvesting algorithms to boost your after-tax returns but it will only work if they have purview of all accounts as described below.

Beware of Wash-Sale Rule

IRS has put restrictions called the "wash-sale rule" when these losses are not deductible from income. "A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you buy substantially identical stock or securities" according to IRS. This purchase not only applies to transactions in taxable account but also applies to your retirement such as IRA, 401(k) accounts including dividend reinvestments. It also applies to option contracts, securities in your spouses accounts and 529 College Savings accounts. For example you cannot take losses from selling ETF that tracks S&P 500 say SPY and buy it within a month in same or another account including another S&P 500 ETF such as VOO because these would be considered substantially identical. But if you bought IWM ETF which tracks Russell 2000 Index or a large-cap mutual fund, the losses will be deductible. Because wash-rule casts such a wide-net , it is important to be aware of all the transactions in your and your spouse's portfolio including retirement accounts and other automated investments. Also, you have to be careful about selling stocks at the year-end to write-off losses and not buying similar position in the beginning of the new year before the 30-day window has elapsed.

Opportunity to Rebalance

The current down market gives an opportunity to "clean up" your portfolio to offset some losses against realized gains thus reducing the taxes when there is a net loss. While tax-loss harvesting allows you to deduct net losses of $3,000 from your ordinary income, you should not make portfolio decisions purely based on tax implications or as saying goes "do not let the tax tail wag the dog"! Evaluating your portfolio, rebalancing and taking advantage of tax-loss without triggering the wash-sale rule can be complicated. Please contact me for help regarding your portfolio decisions.

Updated: Mar 20

Towards the very end of last year (2019), the U.S. Congress passed the SECURE* Act which among other changes, impacted how an inherited IRA and other tax-deferred accounts such as 401(k), 403(b) are required to be distributed from the inherited beneficiary accounts. I would like to give you quick perspective on this significant aspect of change - leaving retirement funds to your beneficiaries.

Death of the Stretch IRA rule

Prior to 2020, beneficiary of an inherited retirement accounts was required to take RMD (Required Minimum Distribution) based on their life-expectancy tables. This was called "Stretch IRA" rule. So if the beneficiary, typically son or daughter, would be drawing down on the account at a much lower rate (2-3%) and thus may not impact their taxes adversely. For example, RMD for an inherited IRA account of $1M would between $2,600 to $3,000 per year for a 45-50 year old prior to the SECURE Act.

However, the SECURE Act changed the time period of distribution of the beneficiary account for IRA accounts to a maximum of 10 years after death of the account-holder with a few exceptions. Since this year, $1M inheritance of a retirement asset would require $100,000 per year withdrawal during the prime time of your beneficiary. While the 10-year draw-down rule provides flexibility on when the funds can be withdrawn, the payout may have unintended consequence of higher marginal taxes, for beneficiary. A beneficiary in 22-24% tax bracket would be paying 32-35% in federal taxes. This also reduces the potential for tax-free growth of the remaining fund during the beneficiary's life-time. Oouch!

Exceptions to the 10-year rule applies to "Eligible Designated Beneficiary", namely

  • spouse

  • child under majority age (18 or 21 depending on the State) or a full-time student

  • chronically ill or disabled and

  • beneficiary who is not more than 10 years younger to the deceased

Once a beneficiary child reaches age of majority (varies by state), the 10-year distribution rule will apply. For example, a 10-year old child could withdraw say about 1.4% to 1.5% until age 18 (majority age in California) or even 26 if the child is a full-time student. Subsequently, the child must take the remaining funds within the next 10 years. This exception does not apply to grandchild.

Need to re-plan on Retirement Spending Strategy

This presents a unique planning opportunity to reduce the impact of taxes on distributions. Typically, retirees take money from taxable accounts first because of lower taxes on long-term capital gains on appreciated investments. A different strategy would be for retirees to withdraw from the tax-deferred IRA accounts first and leave the taxable account to the beneficiary. Thus the taxable investments will receive a step-up in basis to the beneficiary and they can withdraw the appreciated fund without paying any taxes.

Another scenario would be to systematically convert IRA accounts to Roth IRA during the lifetime so that the beneficiary can enjoy tax-free withdrawal from Roth IRA. Nevertheless, the beneficiary must exhaust the inherited Roth IRA account in 10 years but it provides for 10 years of tax-free growth, assuming the funds are needed immediately. For example, a $600,000 fund could easily double to $1.2M in 10 years tax-free.

How to grow Roth IRA account

Roth accounts grow tax-free and can be withdrawn tax-free after 59.5 years and there is no RMD** requirement. On the other hand, RMD from a large IRA accounts could increase the taxes in retirement and increase Medicare premiums since distributions are treated as ordinary income. One should start thinking about building up the Roth IRA account during the earning years. With the new law, "certain taxable non-tuition fellowship and stipend payments" are treated as earned income (according to IRS) and eligible for Roth IRA contribution. This is an opportunity for college students to start saving in Roth IRA.

There are many ways to save into a Roth account instead of traditional tax-deferred account. If your MAGI (Modified Adjusted Gross Income) is under a threshold (example $196,000 for Married-Filing-Jointly in 2020), a couple can contribute $6,000 (+$1,000 over age 50) each towards Roth instead of Traditional IRA, forgoing current year tax deduction. Employers also offer Roth 401(k) option in employer-sponsored retirement plan to contribute funds directly from paycheck and it has no income threshold limit. Another common technique used by high income earners is to perform "backdoor Roth conversion" every year or a more restrictive "mega backdoor conversions" within employer's 401(k) plan. Additionally, it pays to look into opportunities for Roth conversions during lower tax years, for example during a sabbatical or gaps in employment. Another planning strategy is to perform regular Roth conversions of amount that would "fill-up" the current tax-rate threshold but paying taxes now than later. Please contact a tax professional or an advisor for understanding these options.

Revisit your Estate Plan and Beneficiary Designations

With these changes, there is an immediate need to revisit the designated beneficiaries and your Estate Plan in order to save on "inter-generational" taxes. Also, naming secondary beneficiary becomes important to allow for flexibility to partially or fully pass on the accounts to a secondary beneficiary post-death if it makes sense. There are many avenues such as Trusts, Charitable Remainder Trust (CRT), Life Insurance products etc. that should be explored before leaving a substantial amount to your beneficiaries. Consult your estate planning attorney regarding these changes to your estate plan.

As you can see, SECURE Act of 2019 has far reaching implications on your estate plan and it will require careful planning. In summary, the SECURE Act definitely tilts the scale in favor of Roth IRA conversions and Roth IRA contributions if you want to do tax-efficient wealth transfer to your beneficiary.

Please reach out to me on how you can maximize leaving your legacy and not leave a burden of taxes on your beneficiaries.

*SECURE - "Setting Every Community Up for Retirement Enactment.

**RMD - Required Minimum Distribution

Updated: Apr 6

You don't have to be a retiree or in pre-retirement to register with the Social Security Administration (SSA.gov). It is important that anyone with any earned income in the past or present should be signing up for a “my Social Security Account” online via the link here.

Here are some reasons why:

1. Know your benefits: You can download the benefit statement personalized based on your earnings. The statement gives you an estimates of future retirement, disability, and survivors benefits. This is an important step in retirement planning. The statement also can be used to verify the income used for calculations and the Social Security (FICA) and Medicare taxes paid.

SSA sends paper statements only every 5 years between 25-60 years. I came across a situation where the spouse died without having a latest statement. There was no access to the benefit statement for the surviving spouse to know how much benefit he/she can expect from social security without the hassle of going to the nearest SSA office. I would recommend downloading the statement and keep a printer copy with your other year-end statements.

2. Prevent benefit theft: If you are not receiving Social Security benefits, registration would secure your account by preventing others from filing for the claim. In this age of identity theft and data breach, you may not want to be surprised that someone has access to your social security information. Quoting Bob Veres, one of the foremost thought leaders in the financial planning profession, "The bottom line here, I think, is that it may not be possible to protect clients from cyberattacks or cyberfraud, but it may actually be possible to protect them from the consequences of a data breach."

3. Online services: You can view or update your contact information (e.g. phone, address), or get a replacement social security card, replacement Medicare card, replacement SSA-1099 or SSA-1042-S for tax season for those drawing these benefits.

4. Benefit verification letter: For retirees on social security, this letter can be used as proof of income or age when applying for loans, housing etc.

Don't wait to register till you start thinking about retirement! I urge you to use this free service to register online for “my Social Security Account” at https://www.ssa.gov/myaccount/ to not only protect your account but also to have easy access to your benefits and card services.

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