This tax strategy is “one of the great silver linings” of a declining market
Even with talk of a recession and the stock market in the red for most of 2022, some financial experts say the news for those planning to retire isn’t all bad.
Christine Benz, Morningstar’s director of personal finance and retirement planning, offered some strategies that investors can use to find upside potential in a volatile stock market.
Collecting tax losses is a strategy that offers “one of the big silver linings in a down market,” Benz told Yahoo Finance (video above).
“This strategy would apply to your taxable account — so not your retirement account, not your 401(k) or your IRA,” Benz said. “If you have taxable holdings in a brokerage account, the idea is that you can sell them. If they’re trading below what you paid for them, sell them, take a loss, and then you can use that loss to offset gains elsewhere in your portfolio.”
While collecting tax losses can help investors save money, Benz said investors should consult a financial advisor and heed the “wash rule” when selling their securities.
“You can’t repurchase the same security within 30 days of the sale,” she explained, “or you’ll nullify the tax loss.” You cannot sell the same security or what the IRS considers to be a substantially identical security.”
In other words, investors couldn’t sell an S&P 500 index fund (^GSPC) and swap into an S&P 500 ETF (SPY), she added.
Benz also recommended investors convert their traditional IRA plans to Roth plans to save taxpayers’ money because taxes on portfolio conversions aren’t as high in a declining market. She found that this has some advantages.
“On the one hand, tax-free withdrawals in retirement, no prescribed minimum distributions,” said Benz. “That’s why people like the idea of putting money into the Roth IRA column. The benefit of this when the market is down is that your balance is down. And the taxes due on those conversions would be lower than when the market was higher.”
In addition to tax strategies, Benz pointed out that lower stock prices can help investors who, on average, put the same amount of money into their retirement savings on a regular basis.
This is another “silver lining” in a stock market downturn, she said.
“Both stock and bond prices have gone down, so if [you] Dollar cost average or if you are someone who continually moves money into your plan through your 401(k) plan for example, keep doing so as lower prices are your friend when you are in accumulation mode. ‘ Benz continued.
Finally, Benz advises investors starting to save for retirement not to pay too much attention to the daily ebb and flow of their portfolio.
“For people who are in the accumulation phase, I always say a policy of benevolent negligence,” Benz said. “The less you pay attention to your portfolio, the better. A good once-yearly or twice-yearly check-in of this portfolio is sufficient for most people.”
Ella Vincent is the personal finance reporter for Yahoo Money. Follow her on Twitter @bookgirlchicago.
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