By: Bill Lalor CFP®, CFA
Over the past few weeks, the financial markets have experienced extreme volatility due to the COVID-19 pandemic. During periods of volatility, it is often advisable for investors to sit tight and wait for markets to stabilize. However, this ‘inaction’ goes against the very normal human desire to do something when their situation feels out of control.
What can you do proactively during market downturns to put yourself in a better financial position moving forward? Below, I explore four financial planning strategies that are worth considering when markets take a turn for the worse.
1. Tax Loss Harvesting
Tax loss harvesting is the process of selling investments that have decreased in value since the time they were purchased and investing the proceeds into a new security for the purpose of generating a tax-deductible loss. Often, investors are hesitant to do this because realizing losses seems more painful to investors than holding onto the hope that their investment will rise once again. However, when you realize a loss, you are able to offset the loss against any capital gains you may already have or expect to realize, and effectively lower the amount of any potential capital gains tax that you may owe the IRS now or in the future.
While investors enjoy saving money on their taxes, they are also looking to grow their wealth. An effective tax loss harvesting strategy also includes identifying a new investment to own that will grow and potentially recoup the value lost on the security that was sold. It is critical to act quickly after the sale of the security to reinvest the proceeds so that you are not uninvested for a period of time. An experienced advisor will monitor your portfolio and recommend capturing losses when the opportunity arises. Please keep in mind that in any active tax loss harvesting strategy, the IRS prohibits deducting the loss on the sale of a security when you purchase the same (or substantially identical) security within 30 days before or after the sale.
2. Roth Conversions
A Roth conversion is the process of taking all or part of your traditional IRA account and converting it into a Roth IRA. The amount you convert is taxable in the year you complete the conversion, but the assets will then benefit from growing tax-free over your remaining lifetime. We look for opportunities to implement this strategy during significant market corrections since the temporary drop in the value of your converting assets reduces the immediate tax cost of your conversion. Additionally, for investors who are subject to estate taxes, the income tax paid on the Roth conversion will further reduce the investor’s taxable estate.
Traditional IRAs are subject to taxable required minimum distributions (RMDs) starting at age 72. With a Roth IRA, withdrawals are tax-free and RMDs are not required. This allows Roth accounts to potentially grow and compound tax-free for decades. A Roth IRA can even be passed on to your children who can then defer taking their distributions for an additional 10 years. As with any strategy, there are certain requirements that must be met so it is important to consult with your financial advisor before executing a Roth conversion.
3. Refinancing Your Mortgage
One of the silver linings of the recent market turmoil is that interest rates are at or near historical lows. If the current mortgage interest rates are lower than the rates that were available at the time you secured your mortgage, you may be able to refinance to a lower interest rate and save you money on the interest you pay in the long term. Additionally, refinancing strategies can be used to lower your monthly mortgage payment, free up equity for your personal liquidity needs, or consolidate debts.
4. Establish a GRAT to transfer assets to the next generation:
Grantor retained annuity trusts (GRATs) are a great planning tool to transfer assets with little to no gift or estate tax consequences. A GRAT is created when an individual (the grantor) contributes assets with high appreciation potential to an irrevocable trust for a fixed term. The grantor then receives an annuity stream from the trust over the fixed term. The annuity stream is calculated by using pre-determined interest rates set by the IRS. When the fixed term ends, the remaining assets in the trust are then distributed to beneficiaries of the trust, normally the grantor's children.
A market downturn creates a great opportunity to fund a GRAT. Ideally, assets with depressed values are moved into the trust so that when the markets recover, the appreciation on the assets is outside the grantor’s taxable estate. Furthermore, this strategy benefits from low interest rates by creating a lower annuity stream and thus, increasing the remaining amount passed on to the beneficiaries. We prefer using GRATs because they have little downside risk. If the assets earn less than the pre-determined IRS interest rate, the assets then revert back to the grantor’s estate. In these cases, the only real cost to the grantor are the legal fees in connection with the creation of the GRAT.
How We Can Help
As you can see, there is a lot to consider when making adjustments to your financial plan during a market downturn. The COVID-19 pandemic has created a significant market dislocation and mass uncertainty amongst individual investors. There is no reason to go through this alone; a trusted financial advisor can help you take advantage of the opportunities that have arisen. At Simon Quick we have the experience to guide you through this process. Please call us at 973-525-1000 or email Info@simonquickadvisors.com to set up a consultation.
About Bill Lalor
Mr. Lalor serves as the Head of Financial Planning where he employs his extensive experience to oversee the firm’s financial planning services. He is based in our Morristown, NJ office. His expertise includes tax, retirement, and cash flow planning, as well as executive compensation. He also manages some of the firm’s family relationships, endowments, and foundations. Mr. Lalor earned an MBA with a finance concentration from Rutgers Business School. He graduated with a BS from Rutgers School of Engineering where he majored in Ceramic and Materials Engineering. Mr. Lalor became a CERTIFIED FINANCIAL PLANNER™ practitioner in January 2007 after completing Fairleigh Dickinson University’s Program for Financial Planners in 2006. He completed his Chartered Financial Analyst (CFA) designation in 2014. To learn more about Bill visit his LinkedIn.
Simon Quick is an SEC registered investment advisor with offices in Morristown, New Jersey; Chattanooga, Tennessee; and Denver, Colorado. A copy of our written disclosure brochure discussing our advisory services and fees is available upon request. References to Simon Quick as being "registered" does not imply a certain level of education or expertise. No information provided shall constitute, or be construed as, an offer to sell or a solicitation of an offer to acquire any security, investment product or service, nor shall any such security, product or service be offered or sold in any jurisdiction where such an offer or solicitation is prohibited by law or registration. Additionally, no information provided in this report is intended to constitute legal, tax, accounting, securities, or investment advice nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. It should not be assumed that future performance of any specific investment or investment strategy will be profitable, equal any corresponding indicated performance level(s), be suitable for your portfolio or individual situation, or prove successful.