Tax loss harvesting, Roth conversions among opportunities as markets gyrate
With coronavirus, skyrocketing unemployment, vacillating markets and interest rates near all-time lows, the last few months have been uniquely rough on clients.
True, those negatives have been partially offset by swift action on the government’s part in passing pieces of major legislation to aid Americans affected by COVID-19, chief among them the CARES Act. But understanding the importance of those laws — never mind taking advantage of them — can prove baffling to the average layperson.
Financial professionals are being put to the test. Let’s rise to the occasion. We can help our clients through this fraught time by finding the right opportunities in the right moment. We can help our clients put markets in perspective and demonstrate the importance of working with a trusted advisor. We can help them finally put that financial plan in place or put that retirement income plan back on track.
Simply put, we can make some of the biggest differences in our clients’ lives.
We can start such conversations with clients by reviewing the basics — assets and liabilities, income and expenses, insurance coverages, and legacy plans. From there, you can help them determine where they want to be tomorrow and put a plan together to get there — or revise their existing plans.
Many clients have seen decreases in holdings in their investment accounts, making this a good time to discuss tax-loss harvesting. Capital losses can be used to offset capital gains, and potentially up to $3,000 of ordinary income. Losses that aren’t used to offset capital gains or ordinary income can be carried forward indefinitely. Just stay clear of the wash-sale rule, which prohibits reaping the tax benefits of selling a security at a loss if the investor buys back the same security, or a “substantially identical” security, within 30 days of the sale.
Another potential area of opportunity lies in clients’ employer-sponsored retirement plans. These accounts have also likely experienced market volatility. While employer-sponsored plans can now more easily offer guaranteed income solutions thanks to the SECURE Act, many plans do not do so today. Approximately 80% of 401(k) plans permit for in-service distributions once the employee reaches age 59 ½. We should evaluate the benefits to clients at or near this age of rolling an in-service withdrawal to an IRA. This can provide clients with additional investment selections, including those that provide guaranteed income in retirement.
Now more than ever, the guaranteed income component of retirement planning is of critical importance. Clients near or in retirement may now have a withdrawal rate that they are no longer comfortable with. Leveraging guaranteed income solutions for part of the overall portfolio lessens reliance on other parts of the portfolio — and helps clients better weather the current conditions.
Decreases in some holdings in IRAs may provide good opportunities for Roth conversions. The current lower tax rates created by the Tax Cuts and Jobs Act expire at the end of 2025; 2026 could usher in higher tax rates, making Roth conversion less costly now. Remember, clients can do partial conversions being careful not to move into the next income tax bracket.
Truly, this is the time to ensure that a client’s legacy plan is in order. Start by asking the last time they updated their will, durable power of attorney, health care proxy (or durable power of attorney for health care) and living will. Clients should also review any trusts they had established to determine if any updates are needed.. It’s also a time for beneficiary reviews, as wills only cover probate assets and not accounts where beneficiaries are listed, such as 401(k)s, IRAs, life insurance or annuity contracts, securities with a transfer on death, or bank accounts with a payable on death. (While we’re on the topic, this is also a time to review our own life insurance to ensure our loved ones are cared for at the time of our ultimate demise.)
Gifting and estate taxes
This is also a time particularly well-suited for those with gift and estate tax issues. Gifting assets while values are depressed can allow clients to gift more shares. Then, when asset values rise, any future growth will occur outside the estate. This is the case whether simply leveraging outright gifts, using the $15,000 annual gift exclusion or leveraging lifetime gifts using the $11.58 million exemption through gifts in trust.
At the same time, the window is beginning to close on the current all-time high unified gift and estate tax exemption, which kicked in under the Tax Cuts and Jobs Act. Currently, clients have a unified exemption of $11.58 million per individual — but that will drop by half in 2026. Additionally, given the low- interest-rate environment, certain estate planning techniques, such as leveraging grantor retained annuity trusts, sales to intentionally defective grantor trusts, and intra-family loans, can work very well. All of this points to the current moment being an optimum time to review estate plans.