A financial strategy reboot is recommended from time to time, and right now — with the Coronavirus pandemic throwing everything out of whack — we’ve identified a few smart strategy shifts to help you weather the storm.
Here are five things you should consider and discuss with your financial advisor.
#1: If you’re in retirement, evaluate cash flow needs for the next 12 to 24 months, and where to source it.
In other words, identify specifically which assets in your portfolio would be best to liquidate to provide you with the cash you’ll need.
How to know which assets are best?
In normal times, investors might sell a portion of every asset to fund their needs. But, as you well know, we’re not in normal times, and selling a little of everything isn’t the wisest strategy right now. That’s because if you sell assets that are down significantly, you may not have the necessary time to recover your losses.
On the other hand, if you sell areas of your portfolio that have held up better during this current crisis, those areas that are significantly down will have some breathing room in the coming years to potentially recover some of those recent losses.
Your financial advisor can do an in-depth analysis and determine how each individual asset class has performed, and from there, determine which makes the most sense to use as your source of income in the short term.
#2: Understand how the CARES Act impacts you.
First of all, if you received a stimulus check from the Coronavirus Aid, Relief, and Economic Security Act, it’s important to understand, as part of your financial and tax planning, that these checks are not considered taxable income.
Second, and probably more important, required minimum distributions (RMDs) for IRAs and 401ks have been waived for 2020. There’s only one other time historically that this has happened, and that was back in 2009 when we were in the throes of the last recession.
2020 RMDs would have been calculated based on your account value as of December 31, 2019 — months before the pandemic took its toll on the markets, when your account value would likely have been higher. For that reason, we’re recommending to our clients that if they can source income from elsewhere, it may be advantageous to hold off on taking the required minimum distribution this year.
#3: Consider converting from a taxable IRA or 401(k) to a Roth IRA.
This is a potentially powerful strategy that could minimize your tax liability long term, and could benefit those who are in the accumulation phase as well as those in retirement.
Why now? If you’ve recently suffered losses in a traditional IRA or 401(k) account, it may make a lot of sense to shift what remains to a Roth IRA or Roth 401(k). Converting from a traditional IRA or 401(k) account to a Roth IRA means that any growth that happens inside a Roth will not be exposed to income tax. Furthermore, there’s no RMD from a Roth, either.
Here’s a simple-math example that demonstrates the potential benefit: Say you had $100,000 in a traditional IRA or 401(k) that just lost 20% over the past several weeks, and is now worth $80,000. Converting that remaining $80,000 to a Roth IRA will result in a tax bill — after all, the government sees that as $80,000 in income. However, if we expect a future rebound, and that $80,000 grows back to $100,000 over time, you won’t pay tax on that $20,000.
And there’s an additional layer of potential benefit to this strategy. Because there’s been much speculation that tax rates could increase in the near future to pay for the recent government stimulus packages, your Roth IRA will be spared from those possible higher taxes.
#4: Consider tax-loss harvesting.
The practice of tax-loss harvesting allows you to offset taxes using investments that are down, and although it’s typically an opportunity to consider toward the end of the year (when you’re thinking about taxes), it can be a great strategy to use during market declines.
For example, you might sell investments from one underperforming fund, recognize the capital loss, then shift that money to a similar fund (making sure to follow wash-sale rules).
This allows you to stay in the market, but use the loss to offset any capital gains you may realize in the year. If your capital losses exceed your capital gains for the year, you can use up to $3,000 of your net capital loss to offset your income, reducing your tax.
#5: Rebalance your portfolio.
Rebalancing your portfolio — in essence, neutralizing your asset allocation following a market disruption or to make your asset allocation congruent with your risk tolerance — is another fundamental that is probably already part of your strategy.
Rebalancing effectively involves selling safer assets and buying more aggressive assets, so that asset classes are once again appropriately weighted. And given that markets are currently dislocated, and your asset classes are likely way out of balance, now would be a prudent time to discuss this strategy with your financial advisor.
Would you like to find out if any of these strategies are right for you and your financial goals? Contact us at Ironwood Wealth Management to learn more.