Inflation and interest rates skyrocket. Stocks are plummeting and bond funds could have their worst year ever. What should an investor do?
The standard advice is not to make drastic changes to your long-term strategy in response to short-term turns. Investors who panic and sell during a downturn often miss out on market rallies; others “buy the dip” too soon.
However, “that doesn’t mean I never do anything,” said Roger Young, director of thought leadership at T. Rowe Price.
Here are some things investors can do now in response to changing conditions that do not constitute market timing. Be sure to read the details or, better yet, consult a legal, tax or financial advisor.
Increase your performance: If you still have money in a checking or savings account that yields next to nothing, put that cash to work. Thanks to the Fed’s five rate hikes this year, it’s possible to earn 2% to 4% with little effort or risk.
Many online banks offer 2% or more on high-yield savings and money market accounts insured by the Federal Deposit Insurance Corp. Find such deals at Bankrate.com.
You can also earn more than 2% in money market mutual funds managed by firms like Vanguard, Charles Schwab and Fidelity. These are not FDIC insured but are considered low risk; some invest only in US government securities.
If you can tie up your money for a while, consider buying short-term US Treasuries. On Thursday, annual yields ranged from 2.8% on a one-month bill to about 4% and 4.2% on one-year and two-year maturities, respectively.
You can buy them from the government by opening a Treasure Direct account online at Treasurydirect.gov and linking it to a bank account. Treasury bonds are backed by Uncle Sam and your interest is exempt from state and local (but not federal) income taxes.
“The one- or two-year Treasury has one of the best risk-reward profiles you’ll see in the market right now,” said Chris Wheaton, senior investment adviser at Litman Gregory Wealth Management in Larkspur.
You can’t buy Treasury bonds for an IRA through Treasury Direct, but many brokerage firms will allow you to buy them in an IRA or taxable account. Check if there is a commission.
Some brokerage firms also offer FDIC-insured bank certificates of deposit (called traded CDs) with yields that rival those of the Treasury. In some cases, the yields on traded CDs are much higher than those offered by the same banks to their own clients.
I bonuses: Another option is Treasury inflation-linked I bonds. Your interest rate is linked to the consumer price index and changes every six months. On the first business day of May and November of each year, the Treasury announces the rate it will apply to I bonds acquired within the next six months.
Bonds purchased before November 1 will earn an annual rate of 9.62% for the next six months. Every six months after your purchase, your bonus rate will be adjusted to the then-current rate.
You can buy I bonds in a Treasury Direct account or on paper with a federal tax refund. Purchases are limited to $10,000 per person per year (electronic) and $5,000 (paper). Interest is exempt from state and local (but not federal) income tax.
You must have I bonds for at least one year. If you collect them before five years, you lose three months of interest. You can’t buy them in an IRA.
Tax Loss Harvest: If you have losses on investments in a taxable account, consider selling some to generate a capital loss. When it comes time for taxes, you can deduct these “realized” losses from the capital gains you earned when you sold investments at a profit or received capital gains distributions from mutual funds.
If your capital losses exceed your capital gains this year, you can deduct up to $3,000 in remaining losses from ordinary income, such as from a job or pension. If you still have losses left, you can carry them over to future years to offset first capital gains and then up to $3,000 in ordinary income, until your losses are exhausted.
This strategy can be especially useful in California, which taxes capital gains the same as ordinary income at rates of up to 13.3%.
Warning: If you sell something at a loss and buy back the same or “substantially identical” security within 30 days before or after the sale, you’ll violate the “sham sale” rule and you won’t be able to write off the loss on your statement. of income for that year.
If you want to make a loss but don’t want to be out of the market, you can immediately buy a similar, but not substantially identical, investment. For example, you could sell a Standard & Poor’s 500 Index Fund and buy a US Stock Market Total Fund or a Russell 1000 Fund and get similar returns. Or you could sell a stock and buy a fund that invests in the same industry.
Most people do this in December, when they have a better idea of their tax situation for the year and have received information about capital gains distributions, but you don’t have to wait until then.
Note: This strategy will not create a tax benefit on IRAs and 401(k) accounts.
Roth conversions: If you think the assets held in a traditional IRA are poised for a rebound, “without changing your overall allocation, you could convert part of your traditional IRA to a Roth account,” Young said.
The converted amount will be taxed as ordinary income, but from then on, you generally won’t pay taxes on the Roth IRA. (Earnings in the account may be taxable if you withdraw them before meeting certain holding requirements.) By comparison, if you keep the money in a traditional IRA, every dollar you take out will be taxed as ordinary income.
You can also convert money from a traditional pre-tax 401(k) account to a Roth 401(k), if your employer allows it.
There is no income limit to do a Roth conversion; nor is there a limit on the amount you can convert at any one time.
Another benefit: When you turn 72, you won’t have to take required minimum distributions from your Roth IRA each year, like you do with a traditional IRA or 401(k). However, those with Roth 401(k)s generally have required distributions once they reach age 72, if they haven’t already rolled those dollars into a Roth IRA, said Jeffrey Levine, director of planning at Buckingham Wealth Partners.
In addition, heirs (other than a spouse in some cases) must take required distributions from inherited Roth accounts, just as they would with traditional IRAs and 401(k) plans.
Caveats: Additional income from a conversion could put you in a higher tax bracket, cause a temporary surcharge on Medicare Parts B and D premiums, or affect taxes on Social Security benefits. And once you convert assets to a Roth account, you can no longer undo or “recharacterize” the conversion.
“Market declines are a good opportunity for Roth conversion,” Wheaton said. “Assets are worth less and if you think there’s going to be a rebound in the next couple of years, it makes sense to convert some.”
Stock Compensation: If you exercised stock options or purchased restricted stock units earlier this year when stock prices were higher, “consider whether you need to reassess your strategy,” said Helen Dietz, West Coast managing director of Aspiriant, a firm wealth management.
When restricted stock units are awarded, the grant date value is added to your ordinary income for the year. The company will withhold a certain amount to cover taxes, but it may not be enough to cover the full amount owed. If the stock price has gone down, you may want to sell some stock for cash and take a capital loss. (See tax loss collection above.)
Similarly, if you exercised nonqualified or incentive stock options earlier in the year and haven’t sold the underlying shares, “consider whether it still makes sense to hold them,” Dietz said. There could be regular and alternative minimum tax issues. “Many articles were written about how tech people exercised stock options in 2000 and were left with a tax liability they weren’t prepared for.”
Estate and gift planning: Wealthy families whose estates might be subject to estate tax may want to give some undervalued assets to their eventual heirs today, when the federal lifetime gift and estate tax exemption is at a record high, $12.06 million per person. This exemption will be reduced after 2025 to $5 million plus an inflation factor, which would bring it to about $7 million in 2026, unless Congress changes the law.
“If you have an asset that is temporarily low in value due to market conditions, perhaps a business or building affected by Covid, now is a good time to consider giving that asset away. You will use less of your federal gift and estate tax exemption,” said Chelsea Suttmann, an estate planning attorney with Barulich Dugoni & Suttmann Law Group in San Mateo.
In addition, anyone can give, to any number of individuals, up to $16,000 each this year without having it counted against their lifetime gift and estate tax exemption. If you have stock, for example, that was worth $20,000 but is now worth $16,000, you could take it out of your estate this year without any gift tax consequences.
Intrafamily loans: The average rate on a 30-year fixed-rate mortgage has more than doubled this year to 6.7% this year. If your children can’t afford a house at that rate and you have available funds, consider making them an intrafamily loan.
“If I want to lend my children $1 million and I want them to pay me back without any gifts, I would have to charge them interest at a rate equal to or higher than the applicable federal rate,” Suttmann said. The Internal Revenue Service sets this rate every month. For October, it will be 3.43% for loans over nine years. That’s an increase from 1.82% in January, but well below commercial rates.
Kathleen Pender is a former columnist for the San Francisco Chronicle. Email: [email protected]
Source: news.google.com