Tax-Loss Harvesting in an IRA
Though tax loss harvesting may seem straightforward in your taxable accounts, it can be more complex when dealing with retirement assets like IRAs due to how their investments are treated differently from taxable accounts.
Losses for new Roth IRA accounts with smaller balances that are valued below their basis and investors who itemize deductions are ideal candidates for tax losses; however, other methods are also available to improve an IRA’s tax position.
Eligibility
Traditional IRAs are individual retirement accounts that enable investors to diversify their investments across an array of assets. While you may incur losses when purchasing stocks or mutual funds, tax loss harvesting offers ways to minimize losses.
Investors holding assets in taxable accounts (such as brokerage and regular brokerage accounts ) can take advantage of tax loss harvesting to their benefit. By selling shares held in a taxable account and replacing them in an IRA account, any capital losses can be offset against capital gains while any remaining net losses can be carried forward to future years.
Investors with tax-advantaged vehicles, however, should generally avoid harvesting losses. Withdrawals from these accounts are subject to tax on an annual basis rather than when sold; making long-term gains more attractive, especially if your tax bracket increases over time.
Taxes
IRA investments cannot typically be harvested for losses; however, with the Tax Cuts and Jobs Act’s removal of numerous miscellaneous itemized deductions, investors will typically need to wait until liquidating their IRA investment before claiming it as a loss. High net worth individuals may choose selling at a loss in order to stay within their income tax bracket or offset capital gains in other accounts.
Harvesting losses allows investors to reduce their current year tax liability by offsetting capital gains and up to $3,000 of ordinary income with harvested losses, which may also be carried forward to offset future gains and reduce taxes in subsequent years.
To avoid wash sales, it is crucial that when planning transactions you take an overall view of your portfolio. A consolidated tax plan and regular reevaluation of investment objectives are vitally important for any investor – our Northwestern Mutual Financial Advisors can ensure all your assets are properly managed and tracked down.
Withdrawals
Although an IRA should be maintained until retirement, the IRS allows withdrawals for certain specific purposes. First-time home buyers can withdraw up to $10,000 penalty-free; and “qualified” withdrawals (those made after 59.5 and having an account open for five years or longer) do not incur the 10% early withdrawal penalty.
Roth IRA conversion is typically the best way to utilize an IRA, as this enables tax-loss harvesting to offset gains in non-Roth IRA investment accounts. Unfortunately, this strategy is unavailable with tax-deferred accounts such as 401(k), 403(b), etc. because buying and selling investments triggers capital gains taxes; additionally, due to wash sale rules which prevent investors from immediately rebuying securities which have previously been sold at losses, and reaping tax benefits immediately; consequently most investors don’t use tax-loss harvesting in taxable accounts – they opt for low fees offered by robo advisors who specialize in offsetting gains with tax losses harvesting instead.
Investments
Tax-sheltered accounts such as 401(k), 403(b), IRA and 529s do not incur taxes on investment gains, meaning investors can build wealth without Uncle Sam demanding his share. On the other hand, those holding taxable brokerage or investment accounts face taxes when their capital gains generate capital gains; to reduce taxes further tax loss harvesting is one way of mitigating them.
This strategy involves selling investments at a loss in order to offset your taxable investment gains, but beware of violating the “Wash Sale Rule,” which disallows losses when an identical investment is repurchased within 30 days after being sold at a loss.
Tax-loss harvesters tend to employ an intelligent strategy when employing this strategy, including an asset allocation that favors stocks over bonds or fixed income investments, which have historically delivered greater returns over time but also carry greater risk.
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