What Should You Consider During a Market Correction or Recession? (Part II)
In part II of things to consider with a market correction or recession, we will focus on tax and long term planning topics. It’s important to note that these are high level things to think through and should not be considered advice for your specific situation. Furthermore, you should consult your financial planner, tax advisor and attorney to understand the implications for your situation.
Tax Planning
Do you have a traditional 401(k) or IRA?
With lower balances of your investment accounts due to the market decline, you may want to consider converting some of your pre-tax assets to Roth (e.g. IRA to Roth IRA). Be sure you have the cash outside of these investments to cover the taxes. Most 401(k) plans offer a Roth by now, but if not, ask your benefits department if they will consider adding it, as well as the ability to convert your pre-tax money to Roth (note: this could take 1-2 months for add these features if they don't exist today). It’s a good idea to discuss this decision with your financial planner and tax professional before making the move.
Do you have any assets with a tax loss?
If so, you may want to consider what’s called tax loss harvesting. The concept is to sell an investment specifically for a loss. This helps reduce your tax liability by offsetting gains in the current or future years . If you don’t have any gains in a particular year, then you can currently use $3,000 of capital losses on your tax return if you took/harvested them. The unused amounts carry forward in perpetuity and can help in future years tax situations. In other words, you don’t lose them. It’s a good idea to discuss this decision with your financial planner and tax professional before making the move, especially given there are other rules to be aware of when repurchasing a similar investment (i.e. wash-sale rule).
Long-Term Planning
Do you engage in gifting to pass assets to heirs?
Consider gifting assets now, while valuations are low and while the support may be particularly helpful to the recipient. In 2022, you can give $16,000 per person in a gift tax free. If you’re married, you and your spouse can give a total of $32,000 this year combined to the same individual.
Thinking of helping with a child’s education account (529 account)? If you haven’t done so already, you can take advantage of the 5 year rule where you can fund 5 year’s worth of gifts to a 529. This means an individual can fund $80,000, and a couple can fund $160,000 right now into a 529 with no gift taxes due. If you decide to do this, talk to your accountant about filing a form 709 so the IRS knows the amount is spread out over 5 years. It’s important to note that you will not be able to gift the usual exclusion amount to the recipient over the next 5 years.
Do you need to update your estate plan?
If you need you need to, consider implementing wealth transfer techniques that take advantage of low valuations and rates (GRATs - Grantor Retained Annuity Trust, CLATs - Charitable Lead Annuity Trust, IDGT - Intentionally Defective Grantor Trust, private annuities). Discuss these options with your estate planning attorney.
Does the change in asset values have an impact on your ultimate distribution of the estate including probate and non-probate assets? Meaning, is Suzie supposed to get the house and Betty was to get the investment account because they were about the same amount?
While the market volatility may seem flat out scary, there are ways to make it work for your good. At the end of the day, a good financial planner in your corner can help guide you through turbulent times and find the silver lining.