5 Financial Planning Strategies for Down Markets
Presented by Renee Bilodeau
No one likes to see their account values fall, but historically, from January 3, 2000, to April 19, 2020 (including the March 2020 market drop), “six of the seven best days occurred after the worst day and seven of the ten worst days were followed the NEXT DAY by either top 10 returns over the 20 years OR top 10 returns for their respective years.”[1] Now, past performance cannot predict future performance, but assuming we have not hit the bottom of the market yet, it is an optimistic outlook that better days are yet to come for long term investors. Keeping this in mind, we have compiled a list of five planning strategies to utilize during the recent down market, while it lasts:
[1] https://www.advisorpedia.com/markets/the-impact-of-being-out-of-the-market/
1.Tax Loss Harvesting
Tax Loss Harvesting is a tax strategy in non-retirement investment accounts, you can take advantage of losses to offset gains, which can help minimize or eliminate your capital gains tax bill. If your losses are greater than your gains for the year, you can also offset taxes on $3000 of your income annually and carry forward losses indefinitely. Be aware that if you want to sell at a loss and re-enter the same or substantially similar investment, you must abide by the wash sale rule.
2.Roth Conversions
Roth conversion is a strategy that involves taking a portion of your IRA funds (pretax dollars), paying taxes on that portion this tax year, and depositing into a Roth IRA where funds will grow tax free. This strategy is beneficial during these times because you are paying taxes on a lower value when the market is down. Then, you are moving assets with potential for appreciation (assuming markets go up) into a tax-free growth account. Provided you have had your Roth IRA for 5 years, distributions will also be tax free.
3.Gifting from your IRA Directly to a Charity
If you are charitably inclined, and markets are strong, Donor Advised Funds (DAF) can be an excellent tax-saving strategy. Donor Advised Funds allow you to move highly appreciated stock (or cash) into the account, not pay capital gains tax, and receive a more meaningful tax deduction in the tax year you make the contribution.
This may not be the best strategy in down markets, but there is a potential solution if you are age 70 1/2, and typically donate to a charity: you may gift up to $100,000 from your IRA directly to a charity. Why do this instead of gifting from other investment accounts? When you withdraw money from a non-retirement account that has any gains, you are required to pay capital gains tax. By donating from your IRA, you can a) reduce your required minimum distribution (RMD) which begins at age 72 and b) you will avoid paying income taxes on the charitable gift.
4.Fund an UTMA/UGMA Account or 529 Plan
Many families that want to contribute to their child’s or grandchild’s financial future or education costs. If that is the case, then consider opening an UTMA/UGMA account. Any gains distributed from these accounts would be subject to the kiddie tax rule and capital gains, which are typically lower than the parent’s or grandparent’s tax rates.
If these funds are earmarked for higher education, down markets may be an opportune time to sell out of the depreciated positions and fund a 529 plan. Why would you do this? First, you are minimizing the taxes paid on distributions from a down market. Secondly, 529 plans have the benefit of tax-free growth and tax-free withdrawals for higher education expenses. In addition to these benefits, 529 plans are also seen more favorably for federal financial aid purposes than UTMA/UGMA.
5.Gifting Cash In Lieu of Assets
Gifting of assets typically results in the recipient carrying over the cost basis of the gift giver. This can provide adverse tax consequences to the recipient if the asset has significantly appreciated. You might think, what if I gift depreciated asset, is that a strategy for down markets? In most cases, gifting depreciated stock is a lose-lose scenario as the carry over basis rules change to the greater of the cost basis or fair market value. This means that no one gets the tax advantage of realizing an asset’s losses.
An alternative—gifting cash instead of stocks. While markets are down, a strategy may be to contribute cash directly into a loved one’s investment account (UTMA/UGMA if a minor). Up to $16,000 can be gifted tax free per person, per donee in 2022. This way, the recipient is capturing the “discounted” rates of buying in a down market, will not have to worry in the nearer term about paying taxes on realized appreciated assets, and can invest according to their interests, time horizon, and risk tolerance.
Be Proactive!
In closing, while the market volatility seen in the first half of the year has us all a little worse for wear, the above strategies can help you take advantage of what down markets have to offer: tax savings for the long-term investor. Everyone’s financial planning situation is different, so please consult your tax specialist and financial advisor to find the best solution for you. If you are interested in a free initial consultation, click here to schedule a time to meet with our team.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. Third party links are provided to you as a courtesy and are for informational purposes only. We make no representation as to the completeness or accuracy of information provided at these websites.
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Presented by Renee Bilodeau
Renee brings a calm and collected approach when working with our clients. Renee helps our financial advisors with investment research, financial planning, and providing caring service to our clients. Renee also is an insurance maven, here to help you with your life, disability, and long-term care questions.
