Focus: Financial - Fall Down Go Crash
Then stand up and brush off your taxes
Photo by Ishant Mishra on Unsplash
This post won’t be for everybody, but for some there could be a tidbit or two to talk with your Finance professionals about. (I am NOT a Finance professional. I have no certificates or special training, other than a BSBA from 100 years ago. I’m just a nerd who has some time on her hands, so don’t just take my word for it. Talk to someone!) If you will derive all of your income from social security and 401(k) money, this discussion may not pertain to you. That is because we’re going to talk about strategies that are associated with brokerage accounts and/or other non-tax advantaged investments.
There seems to be a buzz in the air right now about whether the stock market is teetering on the brink of a big fall. Dunno, but it’s what all the cool kids are talking about. And, of course, cool or not, everybody is talking about taxes because… ‘tis the season after all… So, let’s explore these two topics in the context of my portfolio.
I do have a couple of brokerage accounts (investments not in an IRA or 401(k)). I have these accounts for two reasons. First, my employer was nice enough to give me stock (in return for my blood, sweat and tears). Secondly, I believed that if I was going to retire before I was 59 1/2 I would need a source of income that was outside my 401(k). It turns out I was wrong about that. (See? Talk with a professional!) Regardless of that, I now have that brokerage account and I will use it for income in the initial stages of my retirement. Why do I care if my investments are in a brokerage account or a 401(k) or traditional IRA? Well, because I already paid taxes on what I invested in the brokerage account. I only owe taxes on the gains. And, it turns out, the government in its infinite wisdom has decided this type of money has different tax brackets than money that comes from “ordinary” sources, like 401(k) or, maybe, social security (depending on your income and your state). It’s tracked separately.
OK, so let’s say the stock market is humming along, as it has been for the past several years, and you’re pulling money out of your brokerage account at those elevated levels. You’re going to owe taxes on the capital gains. Now, let’s say the kids are right and the market takes a real tumble (or maybe a few stocks or funds in your portfolio have already hit the skids). I’m going to ask you to suspend belief in all of the things your wise elders have told you about buy low and sell high. I’m going to tell you to look closely at the stocks and/or funds in your portfolio that now are at a loss to what you bought them for and maybe sell them. Actually, I’m going to tell you to talk with your financial advisor about those stocks. If you sell them, you can capture a capital loss to offset your capital gains from earlier in the year (or, maybe even carry them forward) and the NET is what you’ll owe taxes on. That would be a REALLY DUMB idea if all you were going to do was sell your stock at a loss and forgo all of the gains you would have gotten by holding until the market comes back, but you’re not done yet. If you use the proceeds to buy another stock or fund that you believe will perform similarly to the one you sold, you haven’t lost anything. You’ll ride the market right back up again with the new vehicle, but you will still have captured the loss to offset your gains for your taxes. They call this loss harvesting. *There are lots of rules about this.* You can’t sell Apple and then turn around and buy Apple, for instance. In fact, you can’t sell a fund that is mostly Apple and then turn around and buy a similar fund. The government gets really testy about stuff like that, but if you’re working with someone who knows what they are doing, you may be able to stick it to that testy government - or at least not pay as much in taxes as you might have otherwise had to pay. Don’t get me wrong. Stock market downturns are not fun for people in retirement. There are a lot of negatives, but if you can find a silver lining in your silver years… why not? (By the way, this stuff works for bonds and bond funds, too.)
OK, so we’ve established that there is “ordinary” income - from your job, your 401(k) distributions, and maybe social security - and there is capital gains income - from your earnings on already-taxed investments. In my situation, I went from a pretty good paying job (read pretty high tax bracket) to getting most of my income from my brokerage accounts and “shifting” my taxes to capital gains. That means my ordinary income, (I still have a bit from a gig job) will be at a much lower bracket than it was when I was working. In my working life, I put money in my 401(k) before it was taxed because my bracket was high. I rolled some of that into an IRA. Now that my ordinary income bracket is low, I can take some of that tax deferred (IRA) money, have the government tax it at the lower rates, and roll it into a ROTH IRA. Now, my money grows tax free and I can take it out tax free. Why in the world would I want to pay taxes on money I’m not going to use for years - and I may actually never use? Because, it gives me some flexibility. Later in my retirement, when most of my income is coming from my 401(k) and social security (both ordinary income sources) my ordinary income could bump up against the higher brackets. If so, rather than traveling into those higher brackets, I can take from my ROTH IRA and never cross the line into the higher brackets. OR, I can leave tax free money to my heirs (who have no idea how good they have it with me). So long as they follow the rules, and the government doesn’t get uppity and change them, my heirs will thank me, posthumously. I’m sure I’ll get spiritual points for it, somehow.
So, there you go. A couple of topics to shoot the breeze with your CPA about over a few beers. (And, if you’re having beers with your CPA, you’re as big a nerd as I am.) This stuff isn’t going to make you rich, but it may save you and/or your heirs a few bucks. Always focus first on your spending (budget) and your income, but if you have a few financial brain cells left over, a tax plan can be a good use of those. Happy tax season! (There’s something you never hear.)
Next week I’ll do a curated newsletter of the best of the web on each of our 5 pillars: PURPOSE, WELLNESS, FINANCIAL, CONNECTIONS & FUN! See you all then!