Financial Spring Cleaning – Opportunities in Chaos

No one likes seeing the value of their portfolio falling, however, as long-term investors, we should treat market corrections, bear markets and recessions as a normal set of outcomes when they occur. Because we anticipate these types of market environments, instead of panicking, investors should consider it as a time to perform some well-deserved “Financial Spring Cleaning.” Below are a few opportunities investors can focus on while assets prices have fallen:


Gifting & Wealth Transfer

The current lifetime exemption sits at $12.06 million. Making gifts during your lifetime that eat into your exemption can be a powerful way to decrease future estate tax obligations and increase the amount passed to the next generation. The gifted assets grow outside of your estate, thus when your estate tax is due, the growth is not considered as part of the original gift. When asset prices fall, the amount of the exemption used is less. So, if you believe that over time the asset being contributed will grow in value, gifting during a time of depressed asset values can be a great opportunity. In addition, there are strategies that can be employed that don’t utilize your exemption to accomplish a gift of appreciation (Grantor Retained Annuity Trusts as an example) which are worth exploring.


529 Plan Contributions

Like gifting above, contributing to 529 plans while assets prices are lower can also be a great opportunity. The gift amount, growing outside of your estate, is exempt from all taxes (capital gains, income and estate tax) when used for qualified educational expenses. However, not considered by most investors is superfunding, or five-year gift tax averaging. The annual exemption amount today is $16,000. Any gift of that amount or less to any person does not eat into your lifetime exemption amount. Many spouses each gift that amount or less to every child so as not to make taxable gifts. However, if liquidity allows, you have the ability to spread a larger one-time gift (up to $80,000 or $160,000 per couple) over a five-year period. There are some considerations when using this strategy, such as making sure to net out other potential uses of your annual exemption (insurance premiums, etc.), but when market values fall, this can be a very powerful way to supercharge your college savings.


Roth Conversions

A Roth Conversion is a strategy that allows high-income earners who can’t contribute directly to a Roth IRA to contribute indirectly. To execute, the strategy simply requires an administrative step where one transfers a Traditional IRA balance to a Roth IRA account. When done correctly, the conversion will allow one to benefit from the enhanced tax advantages that a Roth IRA offers (tax free growth, no RMDs, no tax upon distribution, etc.). Anyone, regardless of income, can convert a Traditional IRA to a Roth IRA. The cost of the strategy is often related to the tax impact of the conversion, as the entire amount is typically deemed to be considered income at the time of conversion. One of the best ways to reduce your tax burden is simply to make the conversion when asset prices fall.


Tax-Loss Harvesting Losses

Tax-loss harvesting entails the selling of an asset for a loss to offset future expected capital gains. While you can buy back the same (or similar) investments after selling them, you must wait at least 31 days to avoid violating the wash sale rule. While most investors only look to their equities portfolio for losses, fixed income portfolios should also be considered. After a period of rising rates, fixed income portfolios can be a significant source of losses and can more easily avoid wash sale rules when buying similarly rated bonds as a replacement.


Increase Retirement Account Contributions

For those that have the flexibility, increasing your contributions during market sell-offs can be a powerful exercise to fuel long-term wealth creation. For younger investors, this is even more powerful, as their time horizon is that much longer. If your employer matches your contribution, that’s an added bonus.


Educating the Next Generation

Market fluctuations offer a special opportunity to educate the next generation about market cycles and the economy. Depending on the age of the next generation, exposure to a full market cycle has been varied. Even for those that have gone through them, the impact is varied depending on their exposure to financial decisions during that time. Corrections are a powerful time to bring the next generation to the table and explain how decisions are made when things are not going as planned.


Buy Assets on Sale

While easier said than done, history has shown us that buying assets during a market sell-off can increase long-term rates of return dramatically. Sadly, our emotions often get in the way and investors tend to do the opposite – selling assets to avoid further losses. Compounding some of the ideas above (increased contributions and gifting) can provide for exponentially positive outcomes.


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