As we approach year end, we wanted to share some tips that might help you maximize your financial situation. While these strategies might not be right for you, they have helped thousands of people over time attain their financial goals.
- Tax-loss harvesting
Tax-loss harvesting is the process of selling investments that are below the price you paid for them, replacing them with a reasonably similar investment, and using that loss to offset realized investment gains from elsewhere in your portfolio. Even if you don’t have a realized gain to offset, you may be able to use up to $3,000 a year to offset your earned income for your federal taxes. If your loss is larger than $3,000 then you can carry that loss forward indefinitely and apply it to future gains.
When should you use tax-loss harvesting?
When you have a loss on an investment and have lost confidence in its ability to recover.
Let’s look at an example:
- Suppose you bought 50 shares AMC Entertainment stock (AMC) in a brokerage account on September 8, 2021 and paid $47 per share;
- As of December 7, 2021 you would be looking at a total loss of $810.50 or $16.21 per share;
- If you really like AMC and believe that the shares will outperform the market over the next 30 days then you should do nothing;
- However, if you don’t believe there are catalysts to lift the shares in the short-term then you could sell AMC, replace it with a market proxy such as an S&P 500 index fund, and then decide in 30 days whether you want to buy AMC back
In this example, if you sold AMC then you would have harvested $810.50 of losses to help offset any realized capital gains (investments that you have sold for a gain). Please note that the challenge with tax-loss harvesting is that you are restricted from repurchasing the same investment for 30-days, otherwise you undo the effects of the tax-loss. Most custodial platforms (i.e. Fidelity, Charles Schwab, Robinhood, etc.) will not track or alert you of this tax rule, so it is on you to remember. Marking your calendar might be an effective way to track this for you.
Tax-loss harvesting is only possible in taxable brokerage accounts, like an individual account or joint account. This strategy will have no benefit on your company retirement plan, IRA, or Roth IRA.
- Roth IRA contributions
Another option for the cash that is raised from a taxable account stock sale, including in the case of tax-loss harvesting, would be to fund a Roth IRA. If you don’t already have a Roth IRA you can easily open one with Charles Schwab, Fidelity, or TDAmeritrade. You have until the date you file your taxes to fund the account, but do yourself a favor and at least open the account soon.
A Roth IRA is one of the absolute best account types that individuals can save money into. Why? Because the value of that account grows tax-free and money can be withdrawn tax-free after age 59 ½. So, you use after-tax dollars today when your tax rate might be lower than it is in the future. That savings grows tax-free over time and then when you need it later in life you get to take a distribution and pay no taxes on the distribution. There are also no required distributions on a Roth IRA. So, you are not forced to withdraw funds in the future and can manage the account on your own terms.
As long as you make less than $140,000 a year, or $206,000 if you file your taxes jointly, you can save up to $6,000 in a Roth IRA ($7,000 if you’re older than 50). A Roth IRA is a great way to save for retirement and avoid future taxes, when your tax rate might be higher than it is today!
- Retirement plan maximization
It’s bonus time of year! People often ask us about our strategy for bonus time, so we are going to share it with all of you. I like the ⅓, ⅓, ⅓ approach:
- Take ⅓ of your bonus and have fun! Life is short, so use some of your bonus to buy something you want;
- Take another ⅓ and pay down debt, especially credit card debt. Look at the annual percentage rate (APR) on your debt and pay off the highest APR debt first. If none of the APR on your debt is above 5% then great job you and I would avoid following this approach. Paying off debt with an APR of less than 5% doesn’t make a whole lot of financial sense; and
- Save the other ⅓. If you have a retirement plan option that is offered by your employer that isn’t already maxed out then look to save more in that account. For 2021, the contribution limits for 401k and 403b plans is $19,500 per individual, or $26,000 if you’re age 50 or older. If you don’t have a sponsored retirement plan then fund a Roth IRA or Traditional IRA if your income is too high.
Have different approach that works for you? We’d love to hear it.
We hope you find one of more of these strategies helpful. From all of us at Iryss we are wishing you a happy and safe holiday season!
