Charting the Course

What a difference a year makes. This time last year, markets were riding high, the economy was on a roll and people seemed confident as we worked our way out of the pandemic.

Almost like a light switch, those sunny days of 2021 clouded over in 2022, with rising oil prices, falling markets, inflation, higher interest rates, and the war in Ukraine.

But there is opportunity out there, and those who sit on the sidelines might miss out on gains they never knew were possible. I’m not talking about timing the market, pulling money out and hoping to catch a green wave back to the positive. Those schemes hardly ever work.

Market declines offer good opportunities to clean up portfolios by adjusting or reallocating assets so they’re ready when markets turn around. This is also a great time to revisit the team you have in place to manage your financial life. Given the current market climate, a proactive team can make all the difference.

That brings us to tax-loss harvesting, which is another form of investor housekeeping. The practice allows investors to reduce tax liability by selling equities at prices that are lower than they were when purchased. Investors can take losses and use them to reduce the size of capital gains, which are taxable. Losses can be applied in the current tax year or they can be used in subsequent years.

Now that we’ve tidied our equity holdings and tended to next year’s tax bill, this may be a good time to build diversification. Inflation is picking up steam, and interest rates are going higher. Fortunately, there is something an investor can do. Private equity, real estate and private debt are among several solid private-market investment options people can use to diversify portfolios with investments that are not tied to the public equities market. These vehicles also can turn the tide of rising interest rates in the investor’s favor while keeping pace with inflation.

It’s important to keep in mind that volatility is an inevitability. As a matter of fact, the stock market, on average, experiences a 5% decline about three times a year, a 10% decline once a year, and a 20% decline about once every six years. A good example might be the S&P 500 falling by 12% earlier this year before regaining ground in March. Amid today’s economic uncertainty, there is plenty to be optimistic about as we look ahead. Consumer demand is strong, and S&P 500 earnings are expected to set a record in 2022 and another in 2023.

But this is no time to sit and wait. Now is the time that your team of professionals should be reaching out to address any concerns and analyzing any possible action that needs to be taken. The market is ripe for a little housekeeping.

With President Biden and Congress looking at a federal tax increase in 2021, this may be the time to consider converting savings from a traditional IRA into a Roth account for tax friendly features that benefit retirees and their families.  

Roth IRAs were created by Congress as part of the Taxpayer Relief Act of 1997, allowing people to deposit after-tax income into retirement accounts. In return for paying taxes up-front, savors see fewer restrictions and there are no taxes on growth or withdrawals.

But Roth accounts were not created for everyone. Income limits have prohibited high-earning retirement savors from opening Roth accounts, but there is a loophole in the tax code that allows higher earners to benefit from the retirement savings option.

This backdoor Roth IRA strategy allows investors to convert money from a traditional IRA to a Roth IRA. Of course, investors who take advantage of this loophole must pay taxes on the money they move from the traditional IRA, but if the traditional IRA money is moved directly into a Roth, there are no penalties. Once a traditional IRA is entirely converted to a Roth, another part of the loophole opens. Savors can deposit up to $6,000 per year into their nondeductible traditional IRA, then convert that contribution into their Roth and pay no income taxes.    

With a potential tax increase looming, this may be a good time to consider a backdoor conversion to avoid paying a higher tax rate on traditional IRA withdrawals. In addition to Roth investments growing tax free, savors enjoy other benefits as well.

There are no minimum distribution requirements for Roth accounts. That means the government cannot force investors to withdraw their money at age 72, like it can with traditional IRAs. Because Roth IRAs have no required minimum distribution age, a savor can convert traditional IRA savings to a Roth account and leave the money for their children to draw from tax free for up to 10 years.

Also, a savor can withdraw contributions from a Roth account without paying income taxes or a penalty regardless of their age. However, there are restrictions on withdrawing investment earnings for savors younger than 59 ½. But those taxes and penalties are waved if the money is used for certain purposes, such as the down payment of up to $10,000 on a first home, or if the savor becomes permanently and totally disabled.

Earnings also can be withdrawn to help pay for the birth or adoption of a child, or to pay for qualified education expenses, such as tuition, fees, books, and housing, but, in this instance, the savor would have to pay income taxes. The 10% penalty would be waved, however.

Each investor’s situation is different, so it is always a good idea to consult with a financial fiduciary, but generally, Roth accounts are the best type of retirement savings vehicle, by far, and this may be a good time to make the move.

Football season is officially in full swing, Halloween is just around the corner and before we know it, the holiday season will be upon us. Yes, we have finally reached the fourth quarter of 2020, and considering how wacky this year has been, many cannot wait to see 2021.

Before we reach Jan. 1, however, it might be a good idea to sit down with your financial adviser and certified public accountant to explore options for savings this coming tax season.

Tax law provides several avenues for lowering adjusted gross income, which lowers tax liability. With a little consultation, many taxpayers can drop their AGI levels significantly and perhaps even drop it to a lower tax bracket, saving thousands of dollars. Here are a few basic strategies that are worth considering.

Filers can reduce their AGI substantially by contributing maximum amounts to their Individual Retirement Accounts and 401(k) retirement accounts. For example, individuals can contribute up to $19,500 to their 401(k) accounts and for those 50 and over, the maximum is $26,000.

Also, contributions to Health Savings Accounts are tax-deductible. An individual can contribute up to $3,550, and a family can contribute up to $7,100. Individuals who are 55 or older can contribute an extra $1,000.

Meanwhile, individuals on the cusp of moving into a higher tax bracket can avoid paying the higher tax rate through proper investment strategies.

Under IRS guidelines, individuals who make more than $163,300 must pay a 32% tax rate on each additional dollar above that tax bracket threshold. But those additional costs can be avoided through retirement savings. For example, if the individual’s AGI were $182,800, they could contribute the maximum of $19,500 to their 401(k) plan, avoid moving into the 32% tax bracket and achieve a tax savings of $6,240. Married couples who file jointly can see a similar outcome with an AGI of $326,600.

Financial market volatility also can be used to an advantage when investors sustain losses. As painful as they might be, there are ways to turn disappointing investments into tax benefits. In taxable accounts, investors can use losses to offset capital gains through a strategy called tax-loss harvesting. This is an approach that is intricate and complicated, but when handled properly, it can provide a nice benefit to investors. The key is having a proactive advisory team to ensure you are satisfying the requirements of this strategy.

The Internal Revenue Service allows tax-losses to be used to reduce AGI by up to $3,000 in net capital each year. Those who have lost more than that can carry the remaining losses forward for use in future years.

To spur charitable giving amid the pandemic, Congress included a new tax deduction provision in the CARES Act, enacted to provide economic assistance to workers, families, and small businesses.

Normally, tax deductions for charitable contributions only benefit those who file itemized tax returns. This year’s CARES Act is allowing those who take the standard deduction to take an additional deduction for qualified charitable gifts of up to $300 for individuals, or $600 if married. Additionally, an individual who itemizes can deduct 100% of contributions, up from 60%. Corporations can deduct 25% of taxable income, up from 10%.

These are just a few options for achieving tax savings, and there are others depending on financial circumstances. So, it may be a good idea to schedule time with a financial professional this fall, so you can be ready for better days ahead in 2021.

The coronavirus pandemic has taken its toll on our economy, but as bad as conditions might seem, savvy investors are seeing some good news. In fact, this is a unique circumstance that doesn’t happen very often, and some have been waiting years for a tax savings opportunity like this to come along.

Recent legislation combined with economic mayhem caused by COVID-19 has opened the door to investors looking for opportunities to move their retirement savings from traditional IRAs to Roth IRAs.

So, why is that a big deal?

The Roth IRA advantage comes down to taxes and flexibility. The money we deposit into our traditional IRA has not been taxed, so we see a big bang for our buck going into the account, but when we pull the money out after retirement, Uncle Sam is there, waiting for his share. Money placed in a Roth account has already been taxed, so the money we withdraw stays in our pockets. Meanwhile, Roth IRAs allow us to withdraw our contributions tax-free at any time, as long as the five-year aging requirement has been met and the investor is at least 59½ years old.

Also, under the SECURE Act, which became law in 2019, an IRA could cause financial hardships for children who inherit the account. Under the new law, beneficiaries who are more than 10 years younger than the deceased owner must withdraw the entire inherited IRA balance within 10 years. In most cases they must pay taxes on the money, and the financial consequences could be significant for lower-income inheritors, who may be bumped into a higher tax bracket. Under a Roth account, there is still a 10-year stipulation, but most inheritors do not pay taxes on withdrawals.

Millions of people have IRAs, usually set up as part of a retirement benefit offered by an employer. Many of those people would love to move that money into a Roth account. In the past, though, the taxable amount on such a move would have been very costly. But, for some investors, those circumstances have changed, and that red light has suddenly turned green.

As everyone knows, we pay taxes according to tax brackets linked to our incomes. The more money we earn, the higher the percentage we pay in taxes. The Tax Cuts and Jobs Act of 2017 lowered tax rates across the board for most Americans. For example, a married couple earning $300,000 per year used to be in the 33% tax bracket. Under the new law, the couple pays 24%.

Meanwhile, the economic crisis caused by COVID-19 has reduced incomes across the country, pushing many into lower tax brackets and further opening opportunities for lower-cost conversions.

This window will not be open forever, though. Under the Tax Cuts and Jobs Act, tax brackets will return to their original levels in 2026. The economic downturn will eventually end, and incomes will improve. Financial markets have already recovered substantial ground, and the unemployment rate is dropping. But more economic instability may be ahead as the pandemic continues, and there are many factors that could determine if this is your year for conversion. Investors should consult with a registered investment adviser and a CPA now, so they can be ready to convert if shifting markets create even greater opportunities this fall.

Stacy Murray is a certified public accountant and a member of the team of financial advisers at Oklahoma City-based Full Sail Capital.