Tax Loss Harvesting and Other Money Moves to Make During a Financial Crisis

Tax Loss Harvesting and Other Money Moves to Make During a Financial Crisis | Ep 205

In Today's Episode

Sean Mullaney joins the show to discuss the money moves you should make during a financial crisis and how to take advantage of tax-loss harvesting.

Tax Loss Harvesting With Sean Mullaney

What You'll Get Out Of Today's Show

  • The 5 money moves to make during a financial crisis
  • What tax loss harvesting is and how to intentionally pursue tax-loss harvesting for maximum tax savings.
  • What a wash sale is and how to avoid it.
  • How to use capital losses as an opportunity to reset your asset allocation or move to a new brokerage that is charging less in fees.
  • What to do if you've already experienced capital losses this year.
  • Why having a Roth IRA can be a huge benefit during times of financial crisis.

Resources Mentioned In Today's Conversation

Sean Mullaney is a financial planner and President of Mullaney Financial & Tax, Inc. The views expressed on this show are not tax, legal, financial, or investment advice for any particular person. Please consult your own advisor regarding your own particular situation.

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Jonathan (00:05): Hey everyone. We recently did an episode called capital gains harvesting

Jonathan (00:56): and we release the episode in early March. And as many of you, if you have a calendar or a pulse right now are aware, uh, March was a very interesting volatile month. Several of you messaged us and said, all right, great. Love the content. Sure it'll be useful at some point. But right now I could, uh, I could really use the deep dive on tax loss harvesting. So we're going to do you one better. We're bringing on Sean Mullaney, the FI Tax Guy. Uh, we're bringing them on the show and we are going to be doing a deep dive into tax loss harvesting and other money moves that you should make during a financial crisis. We're going to break this topic wide open right after this.

Jonathan (02:06): All right, well we have a, we have an ambitious show, uh, to cover. I know we were talking just for a few minutes offline and uh, you know, we were kind of working through, you know, money moves, money moves to make, uh, during a financial crisis. I know we mentioned tax loss harvesting, but what really stood out to me is one of the things that you said, you know, what you really should be telling people is just stay calm. So why don't we just put at the front, at the top of the list on money moves to make, stay calm is your number one thing. Let's talk about that.

Sean (02:34): Yeah, Jonathan. Um, a lot of what we talk about in the FI community are fundamentals. And the idea behind the fundamental is it applies in a whole host of circumstances. It doesn't just apply in 2019 and 2018 when the stock market is fat and happy, right? So sometimes I think we need to step back and say, okay, there are these terrible events that are occurring in the country, but does that really affect my personal finance? And the answer might be a dozen, right? I might be still working at home. My expenses might actually be a little lower than they were before or maybe they do, but they do in limited ways and I still need to use the fundamentals that I've been working on for several years now to address the situation. Right? There's plenty of time to panic. Please do not panic, right? Use the fundamentals first. Please stay calm during this time and I think that's going to serve many members of our audience very well.

Brad (03:24): So Sean, I'm curious, let's talk through those fundamentals from your perspective. Obviously we, you know, we have our ideas here, choose a vibe, but I'd love to hear like what do you, what do you tell your clients, cause almost undoubtedly you've had people come to you who have been saving during good times and now, Oh wow, I'm seeing my net worth drop 10 20 30%. What do you talk to your clients about those fundamentals?

Sean (03:57): One term I'll use is longterm. Meaning you should be making financial decisions that are based on your longterm objectives and the longterm lessons of history. Not based on what was in the newspaper yesterday or what's on the internet today. So I think you need to step back and say, what are my longterm objectives? Let me keep to my financial plan that is based on both my longterm objectives and the longterm lessons of history. Another fundamental I'd say is don't look at your statements. We talk about in the FI community, FI number, right? And we can debate what that number should be and we can talk about things like the 4% rule. And these are very useful tools as we start thinking about these issues. One thing to keep in mind, you're not going to need your portfolio on any one day. The whole idea of building up a fine number or a significant net worth or wherever you want to call it, is that it will support you over many years. And so the idea is, look, you're going to build up a large nest egg of assets. You will essentially take essentially microscopic withdrawals every day, every hour of the rest of your life, right? So if I'm taking a very tiny piece out to support me in two weeks, why do I care what the portfolio balance is today versus yesterday versus tomorrow? Right? There's a lot of noise and we have to sort of strip away that noise and say, what are my longterm objectives and what do the longterm lessons of history teach me in terms of generally achieving my longterm objectives?

Jonathan (05:37): Yeah. You know, and I think what, what comes through here and stay calm is that, you know, you may, you may use the opportunities, the lessons that are coming from coronavirus and what we're seeing in the economy that may tell you that you're not comfortable, you're not, you don't have the tolerance for risk that you thought you did and you might want to make changes, but that's something for the future. That's not something that you want to address in a state of panic right now. Right now, you want to take that longterm view and stay calm. Stay the course. Um, let's go ahead and move gears. You know, we really wanted to put the focus on tax loss harvesting. And as we were sending this over to you, uh, to say, you know, let's, let's break this down. There were, there were two kinds of avatars or personas that came to mind. One is an individual that just wants to know, how do I intentionally pursue tax loss harvesting? Like what is it? What does that mean? What are the implications? You know, what's the why and how do I do that? Uh, then the most optimized fashion. And then the other, and we'll come back to this as part two of this conversation, is the accidental tax loss harvest, or the individual that in March panicked or had or was forced to sell some portion of their portfolio. And as a result has, you know, has created a capital loss, has realized the capital loss. And maybe now much later, they didn't really, they didn't, they didn't know how to safeguard, to protect that. And maybe they just followed the normal plan. And now they're wondering, is there, is there any way now, months and months later for me to optimize on that? So, uh, let's talk about part one two. What is tax loss harvesting?

Sean (07:12): Tax loss harvesting is taking advantage of losses in your portfolio. And when I say portfolio, I mean taxable accounts. I do not mean losses in your IRA, your 401k, your 403B Roth. It's only taxable accounts where you can do tax loss harvesting. So say you've accumulated assets in your regular taxable accounts and coming into Corona virus, they were worth say, $100,000 and you would paid $80,000 for those assets, right? So you had stocks, bonds, ETFs, mutual funds, a hundred thousand dollars value, 20,000 of, they call it built-in gain. Okay? Corona virus happens. Your stock portfolio or whatever the assets are, they go down to say $70,000. So now you're sitting on a position that you bought for 80,000 and it's only worth 70,000. So what you could in theory do is sell all of it for $70,000. Okay? If you then do not rebuy it or rebuy substantially similar, uh, assets for the next 30 days and you haven't purchased some substantially similar assets in the prior 30 days. And we can go into detail on some of these things. You would have a $10,000 capital loss on your tax return. Okay. So in your 2020 tax return, you would report to the IRS. I sold for 70, I bought for 80. I now have a $10,000 capital loss. And so if nothing else happened, you'd have a $10,000 capital loss on your tax return. You could use $3,000 this year for 2020 to offset your other ordinary income, right? So your W2 income, your 1099 income, any other sort of income, interest, income, those sorts of things. What would then happen though is, well, I said $3,000, not $10,000, so $7,000 of that loss gets carried forward to 2021 and you replay the cycle getting to deduct up to $3,000 in 2021 against ordinary income. And that goes on into perpetuity until your death. Um, so tax loss harvesting is a way to realize a loss, possibly reinvest in the same assets, but it has to be at least a month later and has to meet other terms and conditions and then, you know, keep using losses potentially in the future as well.

Brad (10:03): So Sean, just a little bit of nuance. I wanted to just ask a couple of questions to clarify. So can you talk us through, I guess when we're talking about your exact example, right? So we have $80,000 of cost basis where evidently we're selling all of it for $70,000, but talk us through short and longterm gains and losses I guess. And also that some of those items, depending on like if we're talking like specifically identifying individual ETFs or mutual funds, whatever it may be, like you might have bought some of those that have, that you bought years ago that had a unrealized gain or now realized I guess. Some had a ultimately a realized loss. Can you talk the audience through all of that? Short and longterm. And also some of those items have gained some have losses.

Sean (11:00): Yeah. So let's talk through that. So what's short term versus long term? This is more of a gain concept than a loss concept. Um, but essentially if you have an a financial asset that you've owned for one year or less and you sell it, it's called a short term capital gain or loss. The big problem with the short term capital gain is it's taxes or as ordinary income, right? So longterm capital gains those assets that are gain assets that you had for over a year. Those things qualify for preferred federal tax rates. So zero if you're below a certain income threshold and then 15 and 20% the short term capital gains, they just go on the top of your income as ordinary income. So there can be situations where it really pays to wait a few days to get over that year hurdle so that you, when you pick up a you, you pick it up in the income. Yes. But you pay tax at a much lower rate for federal tax purposes. How that works for losses is generally you have to, you sort of mix and mingle these things. So you say, what are my short term gains? Where are my short term losses? I combine those two and that's what goes on my tax return. What am I short, my longterm gains? Longterm losses. I combine those two and that's what goes on my tax return. If you have both gains, then you just have some ordinary income from the short term you have capital gain and comfort in the longterm. If you have a loss in one and gaining the other, you actually get to offset. So that's a good thing. Um, in terms of the, your second question Brad, um, one thing you really need to do before you pull the trigger on any tax loss harvesting is you need to go into your brokerage account. And what you're going to find is a few things in there. One of them is there will be something, there will be, and most brokerages that I've seen actually do green and red. So it will show your cost basis, the current fair market value, and it will show your unrealized gain or loss. And usually there'll be like a little plus or an up arrow and green font for gains and the opposite red font and a minus or a negative there, or a downward arrow for losses. You don't want to do tax loss harvesting. And then all of a sudden they wait a minute. I actually had a gain in that. And then the other thing you mentioned, Brad, is you can elect through your brokerage how you, you use the term basis, right? So what happens in real life is people buy stock and securities, ETFs, mutual funds at different times, right?

Sean (13:37): So you might have, you know, I bought a hundred shares for a $100 in 2010 and then I bought 200 shares for $90 in 2011. And so on and so forth. You can identify different methods of recovering your cost basis. Um, and so if you know, Hey, wait a minute, you know, the ones from way back in time, those ones have a higher basis. You can elect first in first out recovery versus an average recovery, right? You might, you know, what they're going to generally do is default to an average type recovery of your basis. Now it might be that this is sort of academic because you have such big losses, it doesn't matter. But that is worth looking into both. What is your brokerage saying, your current realized gain or losses and what sort of basis recovery can you obtained by working with your brokerage through their website?

Jonathan (14:32): Yeah. And so there's actually a couple aspects of this. Some of these are really, I think when we get to this next part where we talk about this person that is accidentally in this place and is trying to figure out what to do. Before we do that though, I think we should talk about two other points that for the intentional tax loss harvester. One is, uh, the wash sale rules, which prohibit buying substantially similar assets within a particular window. Uh, can you, can you define that for audience? Uh, so they understand what that means and then we can provide a practical example of that.

Sean (15:02): Yeah. It's a 61 day window, so 30 days before your last sale and 30 days after your loss sale. So give you an example, right? So if I sell on May 1st I sell a bunch of stock at a purported loss, right? The financial institution will show that, but then I have to look to the day of that sale and 30 days beforehand and 30 days in the future. If I buy substantially similar securities to what I sold at a loss, I now have a so-called wash sale and so they're going to eliminate the loss. If you know, if I buy a hunt, you know if I sell 200 a loss, but 15 days before or after, say I bought a hundred and you know I just buy a hundred the loss in the first hundred that I sold. In my example, I sell 200 the loss on the first hundred is going to be disallowed because of the so-called wash sale rule.

Sean (16:01): And it can be a little tricky sometimes. Say you have a single person and they only have a brokerage account. Generally speaking, the brokerage will compute any wash sale rules, right? And, and these can be triggered by dividend reinvestment, right? So you know, in late March, my mutual fund paid a dividend, I reinvest, and then in April I do some tax loss harvesting. Well, the dividend reinvestment is going to trigger a little wash sale rule. Usually the brokerage will just take care of that. They'll just report that for you. It'll show up on your 10 99 B and you'll just have a little wash sale disallowance.

Jonathan (16:36): Wait, no, that's important. What you're describing then is that it's disallowing just that amount, or is this disallowing the entire, the entire tax loss harvesting on the entire amount? Like does that make sense? Like you, let's say we're talking about 10,000 ...

Sean (16:51): Yeah. So John, that absolutely makes sense. The way it works is share by share. So if I sell for, I sell a hundred shares and try to claim a loss, but 10 days earlier I got a dividend and bought five shares, I lose the loss on the first five shares I sold. So now I only get the loss on 95 shares. That's how they do that. Um, where it gets, so this is a nuance and fortunately the brokerages handled that nuance pretty well. Where it gets a lot stickier is retirement accounts and your spouses activities, right? So if I sell VTSAX at a loss, okay, but I have a 401k at work that also invests in VTSAX and I have my biweekly paycheck and I'm buying in my 401k some VTSAX, that triggers a wash sale.

Sean (17:50): Um, or maybe my wife at work, maybe she's got VTSAX in her 401k and she's got a biweekly pay check and she's now buying VTSAX that triggers a wash sale on my return on, on my sale. It's a joint return in most cases, right? That's going to trigger a wash sale. So these rules, they start off sort of simple with that little dividend reinvestment in my brokerage account and then they've got these tentacles and they start reaching out for your IRAs, 401k spousal assets. So you do want to be careful. Um, tax loss harvesting can be great for cats and dogs. Uh, JL Collins I think use that term in terms of, Hey, you know, years ago I bought this one company, it's going to be a lot less likely that you're in a trigger wash sale because the odds that your spouse or your 401k has that asset not as likely, but if it's a widely traded mutual fund, it can be a little tougher.

Jonathan (18:47): So Sean, you made a great point talking about cats and dogs, but like for the vast, for a lot, for a lot of people in the audience, you know, VTSAX or a total stock market index fund of some sort is probably what a lot of their investments are in if, if they've listened to this show. And, um, I guess I just want to pick your brain on this. Like when you own VTSAX, you own all the companies. That's the point, right? I mean, the point is that you own them all. Uh, so when you're now talking about wash sales and like my understanding after you're doing a little bit of research, uh, I look at how, uh, what physician on fire has advocated for because he does this very intentionally and a white coat investor similar as well. And what they have said is for themselves, it needs to track a different index even if it's somewhat similar.

Jonathan (19:31): So they feel like that that line for them, and this is a moving gray target, but that line for them is if they move back and forth even between something like the S&P500 and the total stock market. So VTSAX versus whatever the ticker is for the S&P, uh, that is enough of a delineation to, to not trigger a wash sale. And then they basically have an amount that will allow them to move in and out of one, uh, to make sure that on a regular basis they're able to capture this loss. Does that meet the sniff test for you?

Sean (20:04): Yeah. So I think Jonathan, it's important to point out none of what we're saying is particular advice for any tax payer. I think what we're we're touching on though is a area of gray, meaning there is no, I can't give you a regulation or an IRS revenue ruling on total stock market index versus S&P500. I certainly think there's merit to the position though a significant merit to the position that the, uh, total stock market index that Vanguard has is largely composed of the S&P500 but certainly not exclusively so. And so I think if you're trying to say that the S&P500 is not substantially similar to the Vanguard total stock market index, I think you've got a solid position there. Um, your mileage may vary and different practitioners may look at it a different way. Um, but you certainly want to have at least some distinction in those funds.

Jonathan (21:00): and this is, this is actually what I really wanted to communicate would be that that position would be probably a stronger position than someone going back and forth between Vanguard total stock market index and Schwab's total stock market index. Right. I agree with that. Yeah. So, so this, this is kind of the nuance that I wanted to, would want it to add. They are tracking different indices.

Brad (21:26): Nice. Hey Sean, I wanted to go back real quick to your example. Uh, so again, this, this person had $80,000 of cost basis. They sold for 70, so they have this $10,000 loss, right? $10,000 capital loss. You said that they can offset 3000 of that in a, in a given year against their ordinary income, which is, which is a big benefit, right? So it's not against longterm capital gains. It's actually against ordinary income at ordinary rates. Right? So I'm curious if there is additional nuance here or strategy that you would, would advise. So let's, let's just add a little extra to this. So let's say that was one account, right? And this, this person has other, uh, you know, additional, uh, I don't know, stocks or mutual funds, whatever, with some, some built in gains. Now, like would you advise them? So they have this $10,000 capital loss from account A. Now in account B, they have, let's say $20,000 of built in cap gains. Now, how would you advise if at all, would you advise them to sell some of that to offset? Does it matter if it's long or short term? Because like we said, that capital loss can go against ordinary income even if it's future years, right? So there's some additional nuance here with time, value of money and when you, you know, so there's a lot of different things to balance and I'd love to hear your thoughts and like what you would advise someone in a situation like that.

Sean (22:58): Yeah. So Brad, yeah, that's a great example. You're sitting on an already triggered $10,000 capital loss. You know, if you do nothing else, you can only use $3,000 this year and then $7,000 in the future. But you're right, if you were to trigger another $10,000 capital gain, you could shelter all of that $10,000 capital gain and now you just net to zero this year, there's just no tax on, on the sum of it. Right? Or maybe you just trigger up to $7,000 this year and get the $3,000 deduction. I would only trigger a capital gain in that case. If you're looking to reallocate your portfolio anyway, meaning, you know, I don't know how much, I mean there's a little bit of a benefit of resetting your basis, right? You could do that. Um, the big thing I'd be looking though for is, okay, I have this asset, it has a $10,000 gain and I don't like this asset. I like this asset 10 years ago, but my risk tolerance has changed, or my thinking on the world has changed. Or this is an actively managed fund with high fees and I just don't like that anymore. So I think this tax loss harvesting could be a great opportunity to reallocate your portfolio, right? Because sometimes you work with folks and you see, Oh, you've got this fund, it's actively managed and it's high expenses. Oh, but you have a $50,000 capital gain in there. We're going to be hesitant to sell much of that cause we don't want to pay a lot of tax today. But maybe if you've already tripped some capital losses, you can, um, you can take advantage and reallocate in a tax efficient manner. The other thing you could do is reset basis, right? Which has some benefits, we call it capital gain or a tax gain harvesting where you have a loss that's usable. You could reset basis. I'd rather, instead though, just carry that loss forward and get the $3,000 ordinary deductions every year. So, but theoretically you could reset basis if that was important to you.

Jonathan (25:00): All right guys, we're going to continue our conversation on five money moves to make during a financial crisis with Sean Mullaney right after this.

Jonathan (25:17): So we're having our conversation. Five money moves to make during a financial crisis. We've talked about tax loss harvesting and now I wanted to come back to the accidental tax loss harvester. Maybe people in the audience, you know, maybe this reflects your own situation and March you panicked and you sold a significant sum and you realized upwards of $10,000 in capital losses and maybe you started getting back in, but now you're hearing this conversation and you're wondering, Oh wait, wait, there's a strategy. So Sean likes the, for the accidental tax loss harvester trying to plan out the remainder of the year. What, what should they be thinking about?

Sean (25:53): I think they need to ask themselves one fundamental question, which is, did I have a wash sale because I bought in within 30 days, right? So if you rebought the things you sold within the 30 days or theoretically because of other stuff we talked about before in the 30 days, then you need to say, okay, I have a wash sale. I'm not going to get that loss. However, my basis in the rebought securities mutual funds, whatever it is, is actually that old higher basis because the disallowed loss goes into that new basis. So maybe at the end of the year I have a new opportunity to tax loss harvest if I navigate the wash sale rules the right way. So that's if you bought in within the 30 days or otherwise trip the wash sale. If you rebought after 30 days, well now hopefully, you know when you navigate the wash sale rules, you have a good loss on your tax return up to, you know, whatever the loss is. Maybe at the end of the year or even now, you could start looking at the other pieces of your portfolio and say, Hey, there's things I want to get out of. I want to reallocate out of that, have taxable gains in them. I can trip some of those gains, get into a better investments for me, and then do that in a way that it nets out so they don't pay a big capital gains tax. Maybe none at all. Maybe I still realize some net capital loss on my tax return.

Brad (27:18): Sean, I think you just illuminated something for me that I was not aware of and I just want to slow down on this and just pointed out and also just ask for some clarification. So with the wash sale, it's not that the, so the loss is disallowed in the current year, but it's not that you screw this up so royally that you don't ever get the benefit of that. Right. It's not that it's just gone forever. You said when you repurchase it adjusts the basis back up of the newly purchased identical asset. Right. So basically you screwed this up but it's not like a permanent screw up. It's just okay, you're back to where you were. In essence, you shouldn't have done this because the wash sale but you're back to where you were. So then you know no harm, no foul in essence and you move along. Am I, am I hearing you right?

Sean (28:07): That's exactly right.

Jonathan (28:07): Oh, so it's like to add some numbers to that. To use your example earlier you had, you bought the shares at a hundred you sold it at 70 that doesn't sound good. But then you re bought it. Maybe it would, it was at 72 73 75 or whatever the, the wash sale rule in this case is now saying, all right, here's what you actually got it for. But your basis is still that original 100 is that, does that accurately describe what you were presenting?

Sean (28:31): Yes it does. But there's even a further nuance. So yes, in a, when you rebuy in a taxable account, that basis addition is fantastic, right? Because it like, like you said, no harm, no foul later on you can get a benefit for that. But what if you re purchased in your 401k or your IRA? There's all sorts of questions theoretically about like, well where does that basis go? And it probably goes onto the assets you rebought in the IRA or four Oh one K and that's useless basis, right? You never have a capital gain when you sell assets in an IRA or a 401k. So this basis, the basis sort of makeup for the wash sale rule is great unless you're messing around in your retirement accounts and that's where it gets sort of painful. And it's you get the, the loss is disallowed and you don't get really any makeup for it.

Jonathan (29:26): That's huge. That's important to know. Okay. Well we just, so we've actually, you've used the term reallocation a a couple of times, so for context money moves that you can make during a financial crisis. We said number one first, just stay calm, follow your plan number two, tax loss harvesting and the, you know, the different variations of that depending on whether it was intentional or accidental. Point number three, reallocation. And let me give you some context. I saw someone in the Facebook group basically saying, Hey, I've been with this advisor that's been charging me a 2% assets under management for years, have been trying to figure out when to move over. But it's going to be, it's going to be so expensive to do that. And now I'm wondering actually right now with what's going on in the market, is this a good time?

Sean (30:08): Yeah. And let me just start up by saying I am not providing investment advice for anyone in this audience. Right. I'm providing some general thoughts here. Talk to your own advisors for investment advice for your own situation. But yeah, let's say you're in that situation. Okay. It may be that with your old advisor, you look at your portfolio and it's like, look, I've got all realized losses now, or I have like a little realized loss, little realized gain, no big deal. So it's not so much tax loss harvesting you're going to do, it's just I'm just going to sell out of all that stuff and invest in a portfolio that I like. Maybe I read a book and they have a more passive portfolio and I like that portfolio or I've come up with my own asset allocation. Well, it's, look, you know, you're taking advantage of a drop in value to get out tax efficiently to then reallocate.

Sean (31:05): Okay. The second thing I would say to your particular person in your Facebook group is you could always look into something called a distribution in kind if you're looking to move assets, right? So you could have assets with a particular advisor and there's an asset under management fee and you don't want to pay that. What you could do is call one of the brokerages, Vanguard, fidelity, Schwab. There are others, right? Those are just some of them and say, Hey, I want to move assets out of an AUM relationship into you guys. I understand your fees are relatively modest, you know, let's get those on the table first, but as long as those are okay, you then work with that new brokerage to achieve what's called a distribution in kind where you know you own 27 shares of Apple at institution a institution B actually moves those 27 shares in kind. If you do that, you don't have a taxable event, so that would be the second piece on. That's not a reallocation piece. That's just speaking to a particular circumstance on the Facebook group. But yeah, reality reallocations great. Now because you have a, you have a tax efficient way of doing a lot of your reallocation in your taxable accounts right now.,

Jonathan (32:15): The other aspect of this is the volatility that comes, like the market's moving around a lot and ideally this happens in one instant, but it sounds like there's some friction involved between getting out of account one and going into account too. Are there any best practices there in terms of minimizing, you know, how long you're out of a market, like catch a falling knife or miss the, you know, best day ever. You don't really want either of those to happen. Um, preferably everything stays exactly the way it is when you get out. And it's exactly the same when you go back in. Right? But what's the reality there?

Jonathan (32:46): Yeah, the reality is in most cases there's going to be a few days lag. Um, and I think, you know, if you look at, you know, JL Collins has that great chart in his book, the Simple Path to Wealth, right? Where it goes back into I believe the 19th century and it has the little tick marks for the oil crisis and 9/11 and Vietnam and everything. And you see a, uh, a longterm trend line. And so Jonathan, I acknowledge your point right there is going to be risk and you have to understand that there is always risk when you sell something on Monday to rebuy on Thursday. We talked about this in the Facebook live event around like Roth IRA or 401Ks and moving between institutions, rollovers and those sorts of things. So I'd say the best practice is to work with the receiving institution, right? They're the ones who are going to be, their interests are most aligned with yours. So pick up the phone, do not, you know, don't over rely on the internet, on this. Pick up the phone, talk to a human being at the receiving institution. They've got incentive to work with you to make this as fast as possible. And they'll know in their circumstance how long it usually takes.

Brad (34:00): Question about the, uh, the distribution in kind, right? So if it's, if it's shares of, of just, uh, a company, like you said, you know, Facebook, Apple, Amazon, something like that, you know, I can see that being fairly straightforward and you're not having to liquidate. But let's say it's some kind of, uh, I dunno, proprietary mutual fund or something, you know, like that, that the, the brokerage that you're moving from, it's, it's their name on it. Have you seen in general practice, like do they allow that to move over? Do you get clobbered with fees? Like are there best practices to work with a scenario like that?

Sean (34:36): Yeah. So what you're gonna want to do, Brad, is go to your receiving institution, the new institution and say, here's my portfolio at the old institution. What can you accept? And what you're going to find is in many cases, especially if it's well-diversified broadly held mutual funds or even a lot of the individual equities, they're going to be able to accept most of it. But a lot of times there'll be, you know, especially if you've got 2030 fund portfolio, there's going to be a handful where they're going to say, we're not actually able to accept that into our brokerage platform. And so at that point you have to do a balancing act, right? It's tax versus investment allocation, right? You might say, look, I don't like having this particular asset, but I am not willing to trigger that capital gain or I don't like this asset. I'm only willing to trigger some capital gain or it might be, look, you know, you know, this asset is an asset I like having, so I just won't move it over and you know, tax consequences, that's a secondary consideration. So you do have to balance considerations in that type of scenario.

Jonathan (35:43): All right, I want to move to the next, uh, the next money move here. I want to talk about Roth IRA and Roth vehicles in general in this current environment.

Sean (35:52): Yeah, Jonathan, I think in the Corona virus downturn, there's an emergency preparedness lesson to be learned. And I talk about this in my most recent blog posts, an ode to the Roth IRA. Uh, it's not going to be surprising to hear that I'm fond of the Roth IRA after all this has gone down. I'm even more so fond of it because, you know, we, we, we've talked about Roth versus traditional, the FI community on infinitum. I think the Roth IRA gives you particular characteristics that are helpful in an emergency. And you know, I've posited on my blog posts, well what if you had a million dollars in a 401k and like a $10,000 emergency fund and that's it. And then coronavirus strikes, right? Well sure you've got that emergency fund and that might not be enough. What if you have to tap into that 401k and you're not aged 59 and a half.

Sean (36:44): That can get messy quickly from a tax perspective because there could be income tax and a 10% penalty. But also if you're still at the employer, you may not be able to get into that 401k. They are not required to let you take in service distributions. They're not required to let you take a loan. So I think the Roth IRA has some really good emergency preparedness aspects. The big one is contributions. You can take your contributions to your Roth IRA back any time for any reason. Tax and penalty free. Now I'm not advising you do that particularly if you're under age 59 and a half, right? You should only take money out of a Roth IRA. If you're relatively elderly, you have a very serious emergency or you're doing a very intentional financial plan such as a Roth conversion ladder strategy right before 59 and a half. Um, but I love the idea that you can save for retirement and have something you can go back to an emergency to get the money out tax-free penalty free and not having to worry about your employer and their plan rules for distributions, right? You call your discount brokerage, fidelity, Vanguard, Schwab, whoever it is and say, Hey, give me some of those contributions back. I have an emergency, not optimal, but I love that strategy of having at least some of your wealth in a Roth IRA so that if a really dire emergency occurs, you've got some ability to access that cash.

Brad (38:19): So Sean tax and penalty free, that's fantastic. Obviously this is post tax dollars that went into the Roth IRA and so it makes sense that that you're not paying tax on it again. And that's a huge piece of nuance that there's no penalty when you're pulling out your contributions. And now that's for no matter how many years in the past, right? So if you've been contributing for the last 20 years and you've put in, I don't know, $5,000 each year or thereabouts, you have a hundred thousand dollars then in this scenario of contributions, you theoretically can pull at any time, all $100,000 of that out tax and penalty free. So it really can operate like an emergency fund.

Jonathan (39:08): Yes. I want to point out, I believe if I'm correct, Sean, that if you take that a hundred thousand you can not put that a hundred thousand back, right Sean? I mean that is that, that that you know, that ability to grow tax and penalty free forever once you pull that money out, that that space is gone for the year.

Sean (39:27): Well Jonathan, under normal rules, yes. What you said is, is absolutely correct. There's one exception now though in 2020, you could take money out if you qualify for something called a Corona virus related distribution. So that means you've, but that means that it's not easily, you know, you need a diagnosis, a dependent needs a diagnosis or you've been negatively impacted by coronavirus because you've experienced adverse financial consequences because of the coronavirus. And again, that's a little subjective. So I don't want to like do tax planning into that, but certainly I can lifeboat into that. Right? Um, but yeah, I think, look, you don't want to take money out of a Roth IRA if you can avoid it, but it's great to have that there. And let's even just contrast that right now to the Roth 401k for a second. Roth 401k is great too, right? All these retirement accounts have a lot of great things for taxpayers. Roth 401k though is subject to the rules of your workplace. So they may not allow loans, they may not allow work, uh, in service distributions and those sorts of things. So the Roth IRA has a lot of advantages over the Roth 401k. These are the emergency preparedness and I'm not here to say the only thing you invest in in the Roth is the Roth IRA far from it. I'm just saying that as a significant tool in everybody's toolbox. Pretty much. I think the Roth IRA needs very strong consideration.

Jonathan (40:57): Now let's look at the practicalities of that choice. So what's interesting when you talk about the Roth 401k versus the 401k, that's an either or. You can do the Roth 401k or you can do the 401k when you're talking about a Roth IRA versus those other two vehicles, it's and you can do the 401k and the Roth IRA. So, so let's just talk about limits here. Income limits with the Roth IRA, married filing joint, I believe the upper limit of eligibility is approaching $170,000 a year. If you make that or less, you're eligible to contribute to a Roth IRA. I know going to check my math and definitely let me know that if I, if I, if I'm close. Uh, but that means like for someone that's up at that making over over a hundred thousand, you know, and, and maybe even closer to the upper end, they're going to be finding themselves in a 24% marginal tax bracket. Uh, and so for that individual, you want to do whatever you can to minimize how much tax you're paying at that highest marginal tax bracket by employing the 401k. And then once you've taken care of that, what else can I do? Oh wow. You're still eligible for the Roth IRA. Let's do that. And keep in mind the benefits that you talked about. Is that like a fair assessment of how this fits in as a financial planning vehicle?

Sean (42:12): Yeah, I think you're looking at it in a reasonable manner. Jonathan. You're saying, look, I'm, I'm paying high tax, so yeah, I've got a $19,504 Oh one K at work. I could max that out and get some really good tax benefits. But there are, you know, first of all, there are other ways to save for retirement and I might need some emergency preparedness. And if I'm married filing joint and I make less than $196,000 of so-called modified adjusted gross income, um, then what I can do is I can still qualify for a Roth IRA contribution this year. So that might be something I strongly want to consider. If I'm married filing joint, my spouse can do that as well. So now we've got $13,000 Roth IRAs and Oh, by the way, I don't even qualify to deduct a traditional IRA contribution in that scenario. So there's no even Roth versus traditional IRA discussion there. Because if I'm married filing joint and I'm covered at work by a 401k plan and I'm making $196,000, I fully qualify for $6,000 Roth IRA, my wife qualifies for six, so it's $12,000. I was off on the math earlier. Apologies. Um, but I do not qualify to deduct my own $6,000 traditional IRA contribution. So why would I do that? I just do the Roth contribution and then I've got $6,000 that I myself can access in the future tax and penalty free anytime, any reason.

Brad (43:44): All right. Sean there was, there was definitely a lot there. So let's, let's just slow down and just, just clarify really precisely. So we're talking, let's talk just about the, the option to choose between a traditional IRA and a Roth IRA. So as I understand it, the income limits for a traditional IRA are significantly lower than that $196,000 you said for the Roth IRA?

Sean (44:10): Yes. Brad. And in fact, you know, it's funny you say that because the income limits for traditional IRAs are around the ability to deduct a traditional IRA contribution. Anyone with any earned income can make a traditional IRA contribution, right? So you can be Tom Brady making $30 million with the Tampa Bay Buccaneers and be covered by the NFL 401k and you can make a $6,000 contribution to a traditional IRA. You can't deduct it. Right. In fact, to fully deduct a traditional IRA contribution when you're covered by a retirement plan at work, your modified adjusted gross income in 2020 needs to be $104,000 or less.

Brad (44:58): Got you. That makes sense. So, right. I mean clearly in a perfect world, it, at least in my perfect world, I, I'm all about the the tax deduction now. So I would love to max out my 401k at work and a traditional IRA. But clearly if you can't because the income limits, that's you, you don't want to put in and knock out the deduction that that does not seem to make any sense to me. So I, your contention of Roth IRA being just a wonderful vehicle, I mean that, that makes a heck of a lot of sense, especially for people in the fi community, right, who maybe already have significant savings and they're just looking for another place to park this right? And Roth IRA while it's, you're not getting a tax deduction now that does grow tax free and you can pull it out tax free at, you know, in the future after 59 and a half, obviously as we've said, you can pull your contributions out at any point, but the growth after 59 and a half, you can pull that out tax and penalty free.

Sean (46:02): That's generally right Brad. There is a five year rule, right? The account has to be five years old and you have to be over 59 and a half to pull out your earnings tax free. But that's usually not going to be a problem if you set up an any Roth IRA in your twenties or thirties you'll meet that five-year rule by age 59 and a half very easily.

Jonathan (46:20): You know, it's so interesting. So if you have these we've mentioned forth for these four vehicles, traditional IRA, Roth IRA, a Roth 401k and your regular traditional 401k if you will. What's interesting about that is, uh, for the, especially when you're talking about traditional IRA versus Roth IRA, to be, to really to be eligible for the traditional IRA, almost by definition, you're going to be in a lower marginal tax bracket to begin with. And if that's all you're looking at, for individuals that are in these lower marginal tax bracket, it's 12% or less, even though they could technically contribute to a traditional and get that tax break. Now that tax break is relatively marginal, pun, halfway intended, and it might be worth it to bite the bullet and just go Roth. And it's kind of the same conversation for the Roth 401k versus the the regular 401k. You know, if you're in a 12% or less marginal tax bracket, like you could make a compelling case for, you know, either or. I mean you really, you really could. Uh, but certainly as you find those marginal tax brackets proceeding up higher and higher starting, you're talking now about 12%, you're talking about 22%, you're talking about 24%. Like do whatever you can to avoid that higher marginal tax bracket by taking advantage of your 401k. And then what's great about that is even then you're, even though you're not gonna be able to take the deduction with the traditional IRA, you're going to be able to do the Roth still. And there's so many advantages to having that in light of the context that we just talked about. So we're gonna let's beat this Roth horse just a little bit more and talk about Roth conversions. That's the thing I want to spend the, that's the last point that we want to make with the five money moves that you should make during a financial crisis. Sean, how, like what's the nuance here between just contributing to a Roth versus making an intentional Roth con conversion?

Sean (48:13): Yeah. So Jonathan, this deals with money that you already have in traditional retirement accounts. Traditional 401k, 403B, traditional IRA, those types of accounts. 2020 is a year of somewhat depressed asset values and it's also a year for many folks of lower income unfortunately. And so there is some tax planning that can be done in down years. And Roth conversion planning is the big, big one. It might be that, you know, you went from a hundred thousand dollars a w two income this year to $50,000 and between you and your spouse, you're now in a lower tax bracket. And so you say, Hey, you know what, we're now in a lower tax bracket. We have some old traditional IRAs over here, some old 401ks. Let's start converting some of that to Roth while we're in a lower tax bracket. Um, it, you know, you have to put some numbers to paper here to well, am I really in a lower tax bracket. Um, those sorts of things definitely think you should put some numbers to paper on this one. The other thing to keep in mind is Roth conversions are irrevocable. So if you listen to this podcast, you say, Oh wow, Roth conversion, that's a great idea. I've got $10,000, an old traditional IRA, I'm just going to convert it right now. You can do that. I'm not advising that you do or don't, but if you do it, you're stuck with it. So what I generally tell folks is what you might want to do this year is wait until the fourth quarter, really understand what your income is going to look like this year. And then as you have a much better idea of what 2020 looks like for you, and you say, Oh wow, I'm in a much lower tax bracket this year. I've got room to fill up that bracket, maybe in the fourth quarter, pull the trigger on some Roth conversions.

Jonathan (49:59): So to add some, add some flavor to this. Uh, you know, the individual that thought they were going to make you know, a hundred K this year maybe and maybe now the year's looking a lot more like 40, uh, they let's just, let's do it. Let's put like a family. Let's put, let's kind of paint this picture of who the, what this might actually look like. Practically. You have a, you have a family with three kids, so married filing joint, three kids. So you've got three child tax credits at play. Uh, if you were to do like a free money calculation, and we've kind of done this in the past, what that might look like, they have up to $78,000 in money that after you incorporate the child tax credit in a, they're paying a 0% federal income tax. They thought they were going to make a hundred. They're only making 40. That means that there is a space there of about $38,000. They have 401ks that they've been accruing for the last five or 10 years. You're saying that in Q4 you're just based on this, this very limited data that we have. There might be a play here to roll, um, $38,000 out of a traditional retirement account, a pretax retirement account and take the hit. But the hit, because they're in a 0% tax bracket is zero and they could get all that money into a Roth and that's tax and penalty free. And it's growing tax-free for, for the, you know, the remainder of their investing timeline until they need it. And that's just like the clearly the most optimized example. There's another example where maybe they're paying a smaller marginal tax bracket and they're willing to have to bring some money to the table. But this is, this is the mindset and this is the overall play with the benefit of this being kind of in November, December and saying, Oh, I know what we're going to make. And there's a space here in our marginal tax brackets.

Sean (51:45): Yeah, you should always be thinking about Roth conversions for any life change or any major downturn. So picking up on your example, Jonathan, maybe you have a single individual out there who was going to go to grad school in the fall anyway and then all this happens and they lose their job that they had in March, but they're still going to just go to grad school in August, September. Their income might be super low that yeah, they could use the standard deduction or the lifetime learning credit tools like that where they could trigger some Roth IRA or Roth conversion income from the traditional account going into the Roth and still be at a federal 0% tax bracket. States they might pay a little tax, but that might be well-worth, right? If you pay, you know Virginia's 5.75 I believe California is higher, but even California is nowhere near the federal. So you might have all sorts of situations where your income is going to be lower for a variety of reasons this year. Why not use that Roth conversion planning to fill up at either 0% tax bracket or a very low 10 or maybe even 12% tax bracket. Get all that future growth into a Roth. Now, while you're a relatively modest taxpayer,

Brad (52:57): And Sean, that's a really important point about the state tax, right? So we're talking, Jonathan's talking about the nuance here of, you know, his number, we didn't on this call, we didn't run the numbers, but let's just use that at $78,000 I know Jonathan has done the math previously. He's talking about a married filing joint. So you're talking standard deduction and then kind of turning the child tax credits into, in essence, like how much taxable income could have to get down to zero. So that's, that's where we're going with that. But so that's all on the federal side, but that's still taxable income for the state side. And it's still at the state income tax rates. So if we're saying like, okay, in a scenario where someone lost their job and you know, clearly there's not great financial times now and they're thinking in the back of their mind, Oh, but I can do that conversion, I don't want them to be in a scenario where $78,000 times 6% state tax, right? Like while it's still a small amount of money, it's not going to be entirely tax-free. Right? They do need to consider state.

Sean (54:07): Yes, absolutely. Consider state. What I'll tell you though is so the States generally have lower standard deductions than IRS federal, right? So they're going to start paying income tax sooner, but most States are progressive as well. Right? So you know, your first rate of tax might be 1% or 2% up to, you know, uh, depends on the state. California's being generally being the highest. Um, and then there are some States, Texas, Florida, Tennessee, others where there's no state income tax. So for a good chunk of our listeners, this part of the conversation is entirely academic. Um, but yeah, so you always want to keep the States in mind. But like you said, Brad, the numbers may turn out. Yeah, there's taxable income, there's some tax. But you know, if you could do it federal tax free and pay say a 4% state tax rate, I think future you is going to be very happy with 2020 you for paying 4% tax. That future you will entirely forget.

Jonathan (55:06): Yeah, and I think to Brad's point, and I'm glad you brought it up, is to like, you know the clearly like we look for these examples where it's so extreme and it's so optimized that it's a zero like this. If you have to bring money to the table, be aware of what that money looks like, but then if it works to your favor and you can do it, do it. Like it could, it could still make sense. It doesn't have to be a 0% you know, tax conversion in order to make sense for you to Sean, to your point for your future self. So, alright, Sean, I just want to give you the floor here man. Your final, any, any bonus thoughts? Any final thoughts? Uh, thank you so much for coming on the show with us. What, anything else you want our audience to hear or to be thinking about as they're kind of going through this very interesting financial time?

Sean (55:49): Yeah, I think it's just be intentional with your tax and money planning now and know that there are better days ahead, right? That there's definitely gonna be some struggles in 2020 but there are much better days ahead. And I would just say that one term longterm, right? Always be keeping those longterm objectives and those longterm lessons in history in mind as you deal with the financial ramifications of the Corona virus.

Jonathan (56:14): Awesome. Sean, uh, you are an accountant and you also are writing an amazing content at your website. How can people, if they have more questions that they want to follow up with you, what's the best for them to do that?

Sean (56:24): Yeah, so you can follow up with me That's my blog. And then my financial planning practice

Brad (56:33): Brad, I mean, this was a really important discussion, man. There's a lot here and this is not going to be our last financial crisis, right? We are going to have many, many of these over the next 2030, 40 years, but this episode and the content embedded within this is evergreen.

Brad (56:54): Yeah, agreed. And Sean's concept of look at the longterm, I mean, that is music to our ears here at ChooseFI, and that is, that is how I conceptualize the entire fight journey is look at the longterm look, figure out what are your objectives, look at history and move forward rationally and intentionally. And yeah, I just loved that he led with that. And of course we dove into some real, real specifics here that I think will be helpful for people.

Jonathan (57:22): All right, my friends will, if this was a little overwhelming and you're really, you're just trying to get started on your path to financial independence, go to our homepage. You can go to and we've created this, this page for you specifically to maximize the value that we believe, choose if I can offer and to do so in a very non-intimidating way. The key here is not that you understand everything that we talked about, but that you get started and this is one of those things. Your future self will be thanking you for taking action. All right, my friends, stay tuned, stay subscribed. We'll see you next time as we continue to go down the road. Less traveled.

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4 thoughts on “Tax Loss Harvesting and Other Money Moves to Make During a Financial Crisis | Ep 205”

  1. Great Episode!

    Question with regards to COVID-related 401k distributions under the CARES Act:

    Assuming you have a qualifying reason and your employer allows for the distribution, does it make sense (and is it allowable) to distribute your 401k balance and roll it into an Roth IRA (and go ahead and pay tax on any traditional portion of the 401k)? If fees are significantly higher and money less accessible in a 401k, this seems like a perfect opportunity to make this move prior to separation with your employer.

  2. Hi Kevin, thank you to listening to the episode. I’m glad to be presenting the ChooseFI Live Event on Saturday, May 16th (check the ChooseFI Facebook page for more information). There I will address the issue you raise here, but the short answer is that I believe in most (quite possibly all) cases a Roth conversion would not qualify for desirable “Coronavirus-related distribution” treatment.

  3. Kevin, thank you for listening and commenting.

    This Saturday (May 16th) we have a ChooseFI Life Event (check the ChooseFI Facebook page) where I will discuss CARES Act provisions, including Coronavirus-related distributions. I’ll discuss this topic in more detail, but the short answer is generally no – I do not believe Roth conversions qualify as Coronavirus-related distributions.

  4. This episode was awesome! I saved it and will listen again. I am about to make an IRA contribution and had been mulling over “Traditional” versus “Roth.” Your explanation about the “Traditional” deduction being subject to eligibility is the first I had ever heard about this. That definitely includes me, so I will be making a “Roth” contribution, no doubt! Thanks for this info. I have argued with people in the past that said they “didn’t qualify” for the Traditional IRA and had said that “EVERYONE” qualifies. I guess, in hindsight, not being eligible for the Tax deduction is what they meant. Also, I am happy to hear another “Roth Ally” in this camp. I see the point that a lot have about the Roth versus post-tax accounts, but I just love the idea of paying taxes now and forever.

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