Tax Reduction Strategies To Help Your Portfolio During A Crisis

2. Try tax-loss harvesting. In the above strategy, trading inside a retirement account was ideal. But to take advantage of tax-loss harvesting, trades would need to be placed inside a taxable account.

Here’s how it works: Say a fund you’ve invested in has had a sizable loss. You could consider selling that position and buying a similar fund the same day. The buying and selling the same day allows you to capture a loss — which can be used to offset future gains — while keeping your overall asset allocation intact.

Let’s use the 70% stocks and 30% bonds allocation example again. If your stocks include a 20% allocation to small U.S. companies, those investments probably aren’t doing so well right now. Maybe that fund is currently at a $10,000 loss. You could sell the fund, capture the $10,000 loss, and buy something similar to keep your overall asset allocation intact. But be sure you avoid the wash-sale rule to ensure your losses don’t become disallowed.

Tax-loss harvesting has many benefits. It allows you to take advantage of a tax loss, keep your account properly balanced, and retain your exposure for when the market recovers. Selling all of your equities at a loss and not repurchasing similar equities would be a bad idea. That’s because you would be locking in your losses with no potential for recovery.

3. Consider Roth conversions. If you’re in a lower tax bracket now than you will be later, you could make Roth contributions or conversions. When the market is at a lower value — like now — this is a particularly advantageous portfolio management and investment decision.

When you do a Roth conversion, you take money from an IRA (which has never been taxed) and move it into a Roth account. The value of your assets is the amount you’ll report as ordinary income on the current year’s tax return. However, that amount is the value of your assets on the day you make the conversion.

For example, say you moved 1,000 shares of a fund that was trading at $10 a share. You would report $10,000 of ordinary income on your 2020 tax return. Those 1,000 shares, now in your Roth account, can grow tax-free. If in six months those shares increase in value to $13 a share, your Roth account balance is $13,000. Plus, you only had to pay taxes on the original $10,000. A word of caution, however: If your shares end up being worth less than when you originally bought them, there’s not much you can do to “reverse” your Roth conversion.

4. Convert RMDs to a Roth. Traditionally after age 70 ½, you’re required to take out a fully taxable distribution from your IRA or 401(k). This is called a Required Minimum Distribution, or RMD. This year, however, is different. This rule is changing due to the recently passed SECURE Act, which requires you to take RMDs after age 70. However, the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, allows you to skip your RMD for 2020. Therefore, you may want to consider a Roth conversion — especially if you can take advantage of a lower tax rate.

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