Tax Planning During Market Declines
September 4, 2021
September 4, 2021
Market downturns are nothing new. Since 1945, there have been 12 “bear markets,” which is defined as a stock market decline of 20% or more than the previous high.[1] You have likely lived through several of them, which means you probably know two things: market declines are inevitable and there is usually always light at the end of the tunnel.
Many people feel that there is nothing they can do except wait it out and hope the markets recover quickly. But to soften the blow, you can adjust your tax-planning strategies to mitigate losses you incur and capitalize on the return to growth we have historically seen.
You don’t have to hunker down during a bear market; here are three tax planning strategies to consider during a market decline.
A traditional IRA or other pre-tax retirement account allows you to invest more money earlier, granting more time for the investments to grow and benefit from the power of compound interest. But you’ll have to pay taxes on withdrawals from those accounts down the road, and many people believe taxes are only likely to increase as time goes on.[2]
A Roth conversion is an increasingly popular method to pay taxes on those investments while your tax burden might be lower. You can convert all or only part of a traditional IRA to a Roth IRA, but the money you convert will be taxed as income in whatever year you make the conversion.
A market decline may be the perfect time to take advantage of the Roth conversion opportunity. During a market decline, you can convert more of an investment for the same cost as a result of lower share prices. Plus, the future growth of the investment can now grow tax-free when the market rebounds.
Another strategy to consider during a market decline is tax-loss harvesting, which could offer a silver lining during market declines. By deliberately selling some investments at a loss, investors can lower their tax liability on realized capital gains from assets that have performed well.
Tax-loss harvesting isn’t for everyone, and can result in some unpleasant consequences if not executed correctly. While tax-loss harvesting can be a good opportunity within a comprehensive financial plan, it should only be done with the advice of an experienced professional who can help you determine if the strategy will truly benefit your unique situation.
Finally, a market downturn is a good opportunity to maximize your contributions to retirement accounts if possible. This may sound counterintuitive, but let me dig deeper. The key to long-term investing is to buy low and sell high. We don’t recommend trying to “time the market,” but when stocks are low, you want to be buying. So keep purchasing stocks when they’re priced low.
If you’re still working and contributing to a 401(k) or 403(b), consider maximizing your contributions at the end of a low-performing year. Maximizing your contributions means you’re purchasing shares at a low price, keeping more of your hard-earned money for yourself, and lowering your taxable income.
Coign Capital Advisors is a fee-based investment advisory firm based in Draper, Utah. Specializing in serving retirees, business owners, and entrepreneurs, the firm provides holistic wealth management that goes far beyond investment consulting and strives to attain suitable performance combined with solutions that make clients’ financial goals achievable. Led by J. Matthew Zundel, ChFC®, Robert P. Welch, Adam G. Lefler, R. Zeb Lowe, CFP®, Daniel R. Zundel and Courtland Adams clients receive a high level of service from a team with more than 90 years of combined experience. To learn more, visit www.coigncapital.com.
[2] https://www.thesimpledollar.com/taxes/the-future-of-taxes/
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