Proactive tax planning is essential for retirees, so understanding your tax requirements, liabilities, and options is never out of season. A retirement fund’s kryptonite is surprise, whether it’s an unexpected expense or a high tax bill. Good planning and having an adjustable strategy means you’ll have fewer surprises and greater peace of mind.
This article will focus on tax harvesting: what it is, why it’s beneficial, and when it may or may not work in your favor.
Key Takeaways
- There are two types of tax harvesting strategies: tax-loss and tax-gain harvesting.
- Tax harvesting is generally used to reduce tax liability for the current tax year and postpone taxes until rates may be more beneficial.
- Selling and buying assets can affect your MAGI and other retirement benefits determined by your taxable income.
- Regularly and intentionally rebalancing your investment portfolio will ensure your retirement funds meet your needs.
What Is Tax Harvesting?
Like harvesting a vegetable garden, tax harvesting is looking over your garden to bring in the ready product, discarding things that aren’t doing well, and cultivating seeds for the next growing season.
Unlike growing a crop, you don’t have to wait for growing or harvesting seasons to start tax harvesting. Generally, retirees review their investments when preparing their taxes at the end of a tax year when estimating their income is easier. Any gains from taxable accounts are subject to capital gains tax, which can have a shocking effect on your tax bill.
There are two types of strategies to tax harvesting: tax-loss harvesting and tax-gain harvesting.
Tax-Loss Harvesting
The better-known of the tax harvesting options is selling one investment at a loss to offset gains from the sales of other assets. After a low-performing investment is sold to generate a loss, you buy into a similar—though not identical—investment. This realized loss can be used to reduce your taxable income while retaining a similar investment strategy.
Remember:
- Whenever you sell an investment, you will throw off the balance and make-up of your portfolio. You’ll want to find a similar investment to maintain that balance.
- Due to the IRS wash rule, you cannot rebuy the same investment you just sold.
- The wash rule prevents investors from rebuying stock (or substantially identical stock) within 30 days of selling it. Violating the wash rule will prevent you from using the sale to offset your gains.
- Tax-loss harvesting only works with taxable accounts (no help in retirement accounts).
Tax-Gain Harvesting
As you might imagine, tax-gain harvesting is used for the opposite purpose of tax-loss harvesting. It’s selling high-performing investments to realize capital gains intentionally.
You’ll only want to use this strategy when your current capital gains tax is lower than you expect it will be in the future.
There are other use cases to consider, too.
- As a way to offset other losses. As with tax-loss harvesting, your gains can zero out your losses.
- To rebalance your portfolio if one sector of stocks is performing better than expected and throwing off your target asset allocation. You may want to sell off other winning stocks to readjust your asset targets.
Remember:
- You can only harvest taxable accounts, like a brokerage account.
- The wash rule applies to selling and buying identical or substantially similar stocks.
- Realizing capital gains can affect your modified adjusted gross income (MAGI), which determines certain retirement benefits, such as Medicare costs and your tax bracket for Social Security benefits.
Benefits of Tax Harvesting
The specific benefits of these tax strategies are unique to your individual tax situation.
Harvesting strategies are especially beneficial to retirees and investors who are subject to a high long-term capital gains tax category and have various taxable accounts to maneuver.
- Benefit #1: Harvesting assets will offset the gains or losses and reduce your tax liability for that tax year. It will never eliminate your tax requirement, though. It only postpones it.
- Benefit #2: To fully reap the benefits of tax-loss harvesting, you’ll want to look for ways to reinvest your tax savings and give your money another chance to grow. Remember to look for currently low-performing investments that show growth potential. It may feel counterintuitive, but you never know when a loss can become an opportunity.
When looking at tax-gain harvesting, you’ll first need to understand how capital gains are taxed. You’ll then know how much money you may need to pay and if tax harvesting can reduce some of that tax requirement.
There are two different rates at which capital gains are taxed: long-term and short-term tax rates. Long-term capital gains are applied to any asset held for over a year. Your taxable income determines both tax rates.
2023 Long-Term Capital Gains Tax Rates
| Tax-filing status | 0% tax rate | 15% tax rate | 20% tax rate |
| Single | $0 to $44,625 | $44,626 to $492,300 | $492,301 or more |
| Married, filing jointly | $0 to 89,250 | $89,251 to $553,850 | $553,851 or more |
| Married, filing separately | $0 to $44,625 | $44,626 to $276,900 | $276,901 or more |
| Head of household | $0 to $59,750 | $59,751 to $523,050 | $523,051 or more |
2023 Short-Term Capital Gains Tax Rates
| Tax Rate | Single | Married, filing jointly | Married, filing separately | Head of household |
| 10% | $0 to $11,000 | $0 to $22,000 | $0 to $11,000 | $0 to $15,700 |
| 12% | $11,001 to $44,725 | $22,001 to $89,450 | $11,001 to $44,725 | $15,701 to $59,850 |
| 22% | $44,726 to $95,375 | $89,451 to $190,750 | $44,726 to $95,375 | $59,851 to $95,350 |
| 24% | $95,376 to $182,100 | $190,751 to $364,200 | $95,376 to $182,100 | $95,351 to $182,100 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 | $231,251 to $346,875 | $231,251 to $578,100 |
| 37% | $578,126 or more | $693,751 or more | $346,876 or more | $578,101 or more |
Seeing the Big Picture
Whatever tax strategy you use, remember to be intentional about regularly rebalancing and evaluating your investments. Retirees must be mindful of any ripple effects caused by changing their MAGI.
Since a retiree’s income is so interconnected, speaking with a tax professional and a financial planner is essential before making big tax decisions. They can give you insight and direction and help you see the ripples.
This is why tax planning is one of our specialties. You could save thousands of dollars in taxes and strengthen your portfolio if done intentionally. We can help you build a tax plan that helps you take advantage of your gains and losses.
Schedule a free consultation to see what options are available to you.
