In light of recent concerns over the economy, we are all worried about the performance of our investment portfolios. The latest pandemic has spiraled the market into a decline that is proving to be unpredictable. With this has come a lot of uncertainty and a few sour lemons. However, there are actions you can take that will help sweeten things up by putting more money in your pocket and position you for a brighter financial future. Here is how to turn these three major lemons into a refreshing and lasting lemonade.
Lemon 1 – Losses
Regarding your taxable portfolio, you may want to consider replacing positions that have losses. Most holdings, such as EFT’s and mutual funds, can be replaced by a similar fund so you do not lose exposure to that area of the market. The sweetener to add to this lemon is that you can use the loss from the sale of the fund to offset any gains you may have and take up to $3,000 as a tax deduction. Whatever losses you have leftover, you can carry them into future years. If you do not have gains in the future, you can continue to use up to $3,000 in tax deductions in years going forward.
What does recognizing a loss mean for you? If you are in the top tax bracket (Federal 37% + IL 5% – 42%), every dollar of loss can be put to good use. For example, a $1,000 investment that is now worth $850 has incurred a 15% loss. When you are in the 42% tax bracket and deduct the loss of $150, the loss drops from 15% to 7.2%.
Lemon 2 – Reduced Income
Is a reduced income dropping you into a lower tax bracket for 2020? If so, it is worth considering converting some of your IRA dollars into a ROTH IRA. You will pay taxes on this conversion. However, the sweetener we’re adding to this lemon is the tax conversion being a one-time tax in the lower tax bracket you have recently found yourself in. Now your assets can grow tax free. With the stock market down, you should benefit from a greater appreciation in value once the crisis has abated and the economy is back on track. With a ROTH, you are never required to take distributions in your lifetime. This means when your heirs inherit these accounts, they are not subject to a withdrawal tax.
A note of caution, converting too much into a ROTH can subject you to the higher tax bracket you are trying to avoid, so be sure to coordinate with your advisor and accountant prior to conversion.
Lemon 3 – Falling Stock Prices
Falling stock prices tend to cause panic in some investors. Nevertheless, fluctuations in the market represents business as usual. Purchasing stocks when prices are lower generally lead to profits when prices rise again. A recession is always followed by a recovery that includes a strong rebound in the stock market. By adding the sweetener of an inevitable market recovery, investors should take advantage of the lower prices to position their portfolio for a quick and strong recovery. When the market starts to plunge, that is the time to take advantage of the situation by increasing contributions or starting dollar-cost-averaging in stocks.
Therefore, consider these three lemons key ingredients in making a financial boosting lemonade that will propel you to better returns and lower taxes in the years to come. If history plays out as it has in the past, it will be another 10 years before these opportunities present themselves again. So grab a straw, sit back, and enjoy the refreshing lemonade you have just created.
May 1, 2020