How to Account For Losses in an IRA
When it comes to retirement accounts, the IRS is unforgiving when it comes to losses in IRAs. You can only deduct investment losses if all original contributions were nondeductible and the account had a “basis.”
But should rebalancing be considered an appropriate response to IRA stock losses?
Tax loss harvesting
Tax loss harvesting strategies can be effective, but not suitable for everyone. While they can be cost-effective, this strategy requires selling and repurchasing securities which may incur fees that add up quickly. Furthermore, the IRS has added several caveats that make tax loss harvesting ineffective for some investors; specifically the “wash sale rule”.
As for losses in an IRA, they can only be deducted if their account balance is less than their basis. Although this can be complex to navigate, investors looking for optimal after-tax returns should investigate this strategy if taxable investors in higher tax brackets could potentially gain from it. Unfortunately, it doesn’t apply to people with traditional deductible IRAs or itemized deductions below the IRS 2% threshold; such investors would be better served optimizing after-tax returns through other methods.
Rebalancing your portfolio
Rebalancing is one of the best ways to ensure that your portfolio stays aligned with your financial goals and risk tolerance. Rebalancing involves buying or selling investments to bring back to its original ratio; for optimal results, rebalance regularly.
Rebalancing strategies are especially helpful if your retirement savings are held within an IRA, Roth IRA, or employer-sponsored account that offers tax advantages. Selling within these accounts won’t result in short or long-term capital gains taxes; furthermore, taking advantage of stock market swings allows rebalancing to shift money toward underweighted assets and help ensure optimal investment returns.
Although selling at a loss in an IRA may sometimes be wise, if you have several Roth IRAs with different cost bases it may not always be beneficial as your losses won’t necessarily correspond with total contributions and possibly be eliminated under new tax legislation.
Withdrawing money for non-investment purposes
An IRA is a tax-deferred account designed to hold various investments such as stocks, bonds, mutual funds and exchange-traded funds tax-deferred. As these assets fluctuate in value over time, so will your IRA balance fluctuate accordingly. Under former law you could deduct losses that exceeded their after-tax basis (what you paid for investments); however the Tax Cuts and Jobs Act suspended this deduction.
Your IRA funds may become necessary if you need money for non-investment purposes such as buying a home or paying medical expenses, for which ordinary income tax and an additional 10% penalty tax must be paid; reservists called to active duty do not incur this penalty tax. It is wiser to withdraw the money in such a way that will minimize penalties; withdrawing first from Roth IRAs before non-deductible ones might help minimize penalties while keeping your portfolio intact.
Liquidating your IRA
Prior to the Tax Cuts and Job Act (TCJA), you could cash out an IRA and deduct its losses if its total withdrawal exceeded your account’s basis in nondeductible contributions. But to take advantage of this deduction, all accounts of one type IRA (such as traditional and Roth IRAs, SEP or SIMPLE IRAs ) had to be liquidated simultaneously; additionally, itemizing deductions on Schedule A would allow for this advantage.
Your IRA allows you to withdraw funds without incurring the 10% penalty, provided they’re used for qualified expenses such as higher education costs, health insurance premiums, deductible mortgage interest payments and unreimbursed medical costs or first-time home purchases. But by liquidating it now you will lose the opportunity for tax-deferred growth over time.
Withdrawing money from an IRA could compromise its creditor protection benefits, so this should only be done as a last resort if financial trouble has become an urgent matter and immediate cash is required immediately.
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