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This past year was rough on most investment portfolios. Many are worth a lot less on paper than they were in 2007. But there are always ways to turn those lemons into lemonade before New Year’s Day.
Today, I want to tell you about two of your options …
Option #1: Consider Selling Some Losers to Gain a Tax Advantage
I briefly discussed this on my latest installment of MaM-TV. But let me expand on the topic a little bit. When you sell a position at a loss, the IRS allows you to deduct that loss come tax day.
It works like this:
First, if you also booked gains for the year, you’ll be able to offset them on a dollar-for-dollar basis with no limit.
Second, if you recorded more losses than gains — or no gains at all — you can use your losses to offset some ordinary income. The maximum amount is $3,000 ($1,500 if married filing separately) … but you can carry additional losses forward for future tax years.
Doing this before year-end is a no brainer if you have losing positions that you don’t think will ever come back. You will not only get a tax break, but you can then take the proceeds from the sale and reinvest them in better long-term choices (such as solid dividend stocks).
Of course, even if you have underwater positions that you would like to continue holding for the long-term, you still might consider selling them at a loss for the tax advantage.
Why? Because as long as you wait more than 30 calendar days before buying back those same positions, the loss will count on your tax form.
See, the IRS applies what is known as a “wash rule.” Basically, they will not recognize a loss if you’ve bought replacement stock within 30 calendar days before or after you sell your losing position.
However, if you wait 31 days, you’re fine and the loss counts. Aren’t tax laws great?
Now, the real risk is that the stock could rebound over those 30 days and you’d miss out. Yet given the recent volatility, I’d imagine you’ll have another chance to buy back in at a similar (or even better) price.
Obviously, commissions are another factor. But if you’re talking about one or two positions — and using a discount broker — the tax writeoff will more than make up for the little bit of frictional time and cost.
So as the year winds down, take a good look at your portfolio and consider booking some losses.
Option #2: Now Is a Good Time to Convert a Regular IRA to a Roth IRA
Yes, I’m always talking about Roth IRAs. I can’t help it … I think they’re one of the best deals going. As I’ve told you before, they offer you many basic advantages over other retirement plans AND they can be a great way for you to pass along wealth to heirs.
However, they’ve only been around for ten years. So even if you’ve been maxing out a Roth since the beginning, it’s unlikely that you’ve been able to build a huge amount of money in your account.
No problem. You can always convert your traditional IRAs into Roth IRAs. And given the market’s recent slump, now is a great time to consider doing so!
That’s because when you do the conversion, you will be forced to pay taxes on pre-tax contributions and earnings made in the account.
So if the account’s value is down substantially on paper, you will pay taxes on a much smaller chunk of change … and from then on, the money will be able to grow tax-free for you and your heirs.
Before you rush out and convert your regular IRAs, there are a few things you need to know.
First, you currently must fall within a certain income threshold to convert a traditional IRA to a Roth ($100,000 in modified adjusted gross income for both single and joint filers). As of right now, that limitation is set to expire in 2010. Conversions that occur in 2010 will be allowed to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
Second, you will need to have enough money set aside to pay for the taxes on the conversion. Unless you’re 59 ½ or older, the money will have to come from a source outside the account or you’ll pay the 10% early withdrawal penalty, too. And even if you’re of retirement age, I wouldn’t want to see you diminish the value of your account’s future earnings power by using funds from within the account.
Third, the conversion could move you into a higher tax bracket and prevent you from getting other tax benefits like dependent child and college tuition credits.
Still, for many investors — especially younger folks and those looking to leave their accounts to heirs — now is a very good time to consider a Roth IRA conversion.
As always, you should do your homework before making your final decision, and a quick chat with a financial planner or accountant might be worth your while.
But the bottom line is that even though the daily market action is beyond our control, there are always smart proactive decisions that we can make to keep our financial lives as efficient and profitable as possible.
Best wishes,
Nilus
About Money and Markets
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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Michelle Johncke, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.
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