An Individual Retirement Account, or IRA, provides many tax advantages: contributions are either pre- or post-tax dollars and growth occurs tax deferred until withdrawals reach age 59 1/2; withdrawals then become subject to income taxes as usual. Unfortunately, however, an IRA doesn’t allow users to deduct investment losses like other forms of accounts do.
To establish a loss, your IRA would need both tax-deductible contributions and untaxed investment earnings (your “tax basis”). That likely won’t happen.
Taxes
IRAs are tax-advantaged retirement accounts that allow investors to save for retirement tax-free. Any changes in investment values won’t impact your taxes until withdrawals begin being taken from the account.
When taking out a distribution from an IRA, its proceeds are taxed as ordinary income at your current tax rate. But by rolling over funds within 60 days to another account you can avoid having to pay any extra income tax on that distribution.
However, unlike taxable accounts where investment losses may offset up to $3,000 of capital gains, your IRA investments offer no such advantages; rather you may use them against miscellaneous itemized deductions on your federal tax return.
Due to how IRAs are taxed, selling to harvest losses is rarely viable and often not advised. This is especially true for investors with smaller IRA balances than their basis as doing so would limit tax-free growth opportunities within your Roth IRA.
Distributions
Once funds are withdrawn from an IRA, they are no longer eligible to grow tax-deferred. Therefore, it is wise to seek advice from both your financial advisor and tax professional before withdrawing assets that have experienced losses from an IRA. They will help determine if it makes sense for distributions to take place or whether to continue holding onto them for possible future growth.
Keep a thorough record of all investment transactions, such as original cost, sale proceeds and transaction costs for each investment asset you buy or sell. Doing this can help determine your taxable loss and can even allow you to estimate potential deductions related to an IRA loss.
Tax loss harvesting can help IRA beneficiaries maximize their tax efficiency. This involves strategically selling investments with declining values to generate tax deductions that offset capital gains within your IRA and even reduce taxable income. A financial advisor can assist in formulating a comprehensive tax strategy while making sure to abide by all relevant guidelines.
Rebalancing your portfolio
Rebalancing your portfolio is an integral component of investing, helping to mitigate risk and ensure your goals align with your risk tolerance. Rebalancing involves reallocating percentages between asset classes like stocks and bonds based on your needs or advice from your advisor/robo-advisor; for optimal results it should take place in tax-advantaged retirement accounts like traditional or Roth IRAs to minimize transaction costs.
If you need to rebalance in your taxable accounts, be sure to utilize “tax loss harvesting.” This technique allows investors to sell investments at a loss and use those losses against capital gains in other taxable account holdings – potentially helping lower taxable income at year’s end. However, be wary of taking funds out of an IRA to cover expenses such as buying a home or medical bills as this may incur tax penalties.
Asset allocation
Asset allocation refers to the practice of allocating investments across various classes or “asset classes”, including stocks, bonds and cash and equivalents. The purpose of asset allocation is to minimize risk.
Your ideal asset allocation will change over time depending on your goals, level of risk tolerance and investment horizon. For instance, as retirement nears you may wish to invest more heavily in bonds and cash than stocks whereas vice versa for short term investments.
Rebalancing assets within tax-sheltered accounts is often preferable to taking distributions and investing them outside. That way, you avoid incurring the 10% early withdrawal penalty. That being said, any changes you make must consider their tax impact, making rebalancing an ongoing process that should take place regularly so your IRA continues working hard for you.
