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Retirement Planning > Retirement Investing > Income Investing

4 Retirement Tax Challenges to Consider During an Economic Downturn

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What You Need to Know

  • Rocky markets hurt nearly and newly retired investors, but they also deliver key tax planning opportunities.
  • Tax issue awareness can help financial advisors differentiate themselves while also improving client outcomes.
  • While potentially a powerful wealth building technique, tax-loss harvesting is not a silver bullet and must be deployed strategically.

Few investors will need to be reminded of how difficult of a year 2022 has been, both for bond and stock portfolios.

As noted by Joe Elsasser, founder and president of the financial technology company Covisum, those investors who are newly or nearly retired are feeling particularly concerned. All are seeing their well-laid portfolio plans put to the test, and many are finding that they have not adequately prepared for the dangers presented by sequence of returns risk.

Fortunately, the picture is not all doom and gloom for retirement-focused savers, Elsasser says. The current market environment, while painful from an investment perspective, has also raised a number of key tax challenges and considerations for clients.

With a little tax ingenuity, Elsasser says, clients can find a silver lining in 2022’s market woes. At the very least, they can use this year to get a handle on their present and future tax situation.

Collected below are a number of timely tax insights that Elsasser outlined during a recent webinar hosted by Covisum. During the presentation, Elsasser encouraged his fellow advisory industry professionals to take a more proactive approach to integrating tax considerations into the investment management and financial planning process. Doing so will help advisors differentiate themselves while also improving client outcomes.

1. Track and Manage Concentrated Low-Basis Positions

In Elsasser’s experience, it is not uncommon for a new or potential client to come to a meeting and explain that they own, as an example, a sizable portfolio comprised exclusively of Microsoft or Berkshire Hathaway stock they bought decades ago and have never touched.

This is what is referred to as a “concentrated low-basis position,” Elsasser says. On the one hand, it is a good problem to have because of the substantial unrealized wealth contained in the portfolio. On the other hand, so much concertation itself represents a significant risk that the advisor and client should discuss and resolve.

The exact approach to unwinding such a position will depend on the client’s unique facts and circumstances — and likely on the input of a certified public accountant. Federal long-term capital gains taxes of up to 20% can apply to sales of these securities, and there is also a 3.8% net investment income tax and state income taxes to consider.

According to Elsasser, when market prices are meaningfully depressed, as they are in late 2022, this can present an attractive opportunity to realize some of the concentrated low-basis position gains as part of an overall portfolio tax-loss harvesting strategy.

2. Revisit Asset Location Decisions

Elsasser says another common issue he sees with new clients is a lack of an asset location strategy.

“You would be surprised how many investors out there, even those with substantial wealth, have very poor or literally no asset location awareness or strategy,” Elsasser says. “Often you will see a married couple come in with a very complex and inefficient situation.”

According to Elsasser, the current market environment presents a good opportunity to consider strategies such as Roth individual retirement account conversions that can help clients reorganize assets in a more tax-efficient manner.

As a reminder, the deadline for converting traditional IRA funds into a Roth is Dec. 31, 2022, and not — as many people believe — the tax filing deadline in April 2023. Taxpayers who execute conversions in 2022 will pay taxes on the conversion at their 2022 rates, Elsasser notes, which are relatively low and could rise in the future.

3. Beware Poorly Planned Loss Harvesting Patterns

While potentially a powerful wealth-building technique, Elsasser says, tax-loss harvesting is not a silver bullet that is effective in all situations when markets fall, and so it must be utilized as a part of an overall strategic plan.

One obvious point of caution is that tax-loss harvesting works only with taxable accounts, not retirement accounts such as IRAs or 401(k)s. More nuanced is the fact that tax-loss harvesting may not significantly benefit anyone who is already in the 0% capital gains bracket.

For instance, a married couple filing jointly with taxable income significantly below $80,000 already has an applicable capital gains tax rate of 0%.

Finally, selling at a loss and then buying the same security or a “substantially identical” security within 30 days can create a wash sale, which will cause the loss to be disallowed.

4. Consider Implications of Net Unrealized Appreciation

Elsasser says it is common to see new clients come to the table with much or all of their wealth stocked away in a 401(k) account or an IRA. Such investors with significant pre-tax wealth but who are further away from retirement may benefit from “in kind” transfers of assets to taxable brokerage accounts.

One significant opportunity is to transfer depressed company stock in-kind to a brokerage account, which allows the investor to pay ordinary income tax on only the basis.

For example, if a client paid $100,000 for stock that is now worth $500,000, and they then sell the stock and withdraw the money from the 401(k), all $500,000 of it would be taxed as income. But if they transfer the stock in-kind to a brokerage account, only the $100,000 basis will be taxed as ordinary income, while $400,000 will be taxed as an embedded capital gain.

In most cases, the capital gain rate will be lower than the ordinary income rate, Elsasser says, adding that clients might want to stretch out the net unrealized appreciation over a couple of years to stay under the capital gains threshold.


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