By Peter Wechsler
President & Co-Founder, Franklin Retirement Solutions
[email protected]
It’s Wednesday afternoon, and it wasn’t a good day in the market, with the S&P down 1.3% today and 3.2% year-to-date. The tech-heavy Nasdaq is now down 4.7% year-to-date. No fun.
Today’s decline appears tied to the Fed holding steady on interest rates amid ongoing inflation concerns, as well as geopolitical uncertainty surrounding the war with Iran. Rising energy prices and a softer job market are also factors the Fed is watching. Corporate profits remain relatively strong, but these concerns continue to weigh on markets.
Many of our non-IRA accounts at Schwab are in portfolios with individual stocks. You may notice that we might buy and sell more holdings than usual. This revolves around a strategy called Tax-Loss Harvesting, where we sell off some stocks that have lost money and replace them with stocks that will hopefully perform better.
We save those losses so we can use them in the future when you need distributions. Here’s an example:
• You sold off $20,000 in stocks with losses.
• On your tax return, you can take a $3,000 credit against your income.
• The net amount of $17,000 rolls over into your next year’s tax return as harvested (or saved) losses.
• Those losses can be used to offset future capital gains as they arise until you have no more losses to utilize.
This is a great strategy that we can use on your individual, taxable or joint accounts. It does not work with IRAs since none of that money has ever been taxed and you are only taxed on the money you pull out of the IRAs. And with Roth IRAs, there is no tax when you take distributions.
One more strategy to keep in mind: Step Up in Basis. Nobody wants to talk about death but none of us get out of this thing alive. The IRAs you leave behind to heirs come along with taxes, as you’ve never paid taxes on this money. But the money you leave behind in your individual or taxable account passes onto your kids, grandkids, nieces and nephews free of a federal capital gains tax bill. In other words, when you go away, so do the taxes on the gains from these accounts.
Let’s say you bought Apple stock many moons ago. On the day you die, the gains on the Apple stock in your account are $80,000. If you had cashed it in the day before you died, you would have most likely paid a 15% capital gains tax. But because you died before you sold it, it goes to your kids tax free. This is called Step Up in Basis, a major tax advantage of holding highly appreciated property until death.
Wealthy people love this as stocks and mutual funds can grow and pass from generation to generation with nobody paying taxes on the gains unless they decide to sell some of their inherited stock.
If you master these two tax concepts, you will have nailed down a few important parts of the tax code. Since it’s going to be a mostly nice weekend, no more studying until Monday!
Enjoy the weekend…
Peter