5 Year-End Financial Planning Strategies for a Down Market

Maybe we’ll see a Christmas miracle. Maybe it’ll be a cold winter in more than one way. Most definitely, no one will be able to fully predict what happens to the global economy and markets in the coming months. The uncertainty of financial planning in a down market might be enough for some people to shy away from traditional end-of-year strategies and instead stand pat until markets recover.

However, the current market environment creates financial planning opportunities to not only protect wealth but set the stage for future growth.

Yes, even with winter’s gloom approaching.

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Here are five things you might consider doing:

1. Convert Traditional IRAs to Roth IRAs.

Traditional IRAs do not eliminate tax, they defer it into the future. As the account grows, the tax liability grows, too. At some point, the IRS will be there to collect its percentage of your retirement savings, but what if you could buy out Uncle Sam’s interest in your IRA today?

Enter the Roth conversion. It doesn’t always make sense, but when markets are down, likely deflating an IRA’s value, it’s an advantageous time to convert a traditional IRA to a Roth IRA — because of the reduced tax hit to do so — and then enjoy capturing tax-free earnings when the market rebounds.

Additionally, there are new regulations that make inheriting traditional IRAs less advantageous because they will force faster withdrawals from the account than was required in the past. The SECURE Act changed the previous rule to say beneficiaries have 10 years to withdraw funds from an inherited IRA, but the new regulations further clarify that if the IRA’s original owner was already taking required minimum distributions (RMDs), the inheritor must continue taking the RMDs before completely taking out the money by the tenth year of ownership.

By converting that traditional IRA to a Roth, the account owner would not be required to take RMDs — and neither would the inheritors, as long as the money is removed by the tenth year.

A couple of final points on IRAs:

• You don’t have to convert all of an IRA at once. You can do as much or as little as you want — whichever makes the most sense for your current situation. The key consideration here is what level of tax you will pay on the conversion.
• IRA contributions do not have to be maxed out in a calendar year. You have until April 15 to do that, but you may not want to wait. The market can rebound quickly, as occurred during the onset of the pandemic in 2020, so you don’t want to miss potential growth.

2. Lend to a Grantor Trust.

This is an estate tax planning strategy in which someone sets up a trust for their heirs and loans an asset, such as a business or liquid security, to the trust. But with current applicable federal rates (AFR) hovering above 4%, that figure is four times as much as it was a year ago, seemingly making this a less attractive strategy.

However, loaning at 4% with the market down 25% in value is more appealing than 1% with the market at all-time highs. One of the primary benefits of the strategy is that the growth remains in the trust for the heirs, free of any estate tax or inheritance tax. For wealthy individuals, those taxes can be enormous, so simply taking assets and loaning them to a trust, the gains generally avoid being subject to federal estate tax and state estate tax/inheritance tax.

Business owners, especially, are taking advantage of this strategy because their companies are most likely worth significantly less than they were a year ago.

For example, if a business was worth $15 million last year but is down to $10 million today, it has a planning opportunity. That business owner could loan the business to a trust for $10 million (or less in some cases), so if in the future, the company rebounds and sells for $15 million, then the $5 million of gain is generally protected by the trust from the 40% federal estate tax.

Ultimately, the growth potential in this strategy significantly offsets today’s greatly increased interest rates — and frankly, if you don’t expect to see growth higher than 4% for a given asset, this strategy most likely will not produce much, if any, benefit.

3. Make More Aggressive Allocations.

Even more cautious investors are beginning to recognize that they can be doing more to take advantage of today’s depressed markets. While most investing decisions should come after analysis and consultation with a trusted adviser, it is reasonable to consider more aggressive allocations to prepare your portfolio to capture the inevitable rebound.

For example, those without much cash to spend and more conservative investments, such as bonds or real estate, may want to sell and shift the cash to equities. These are typically not drastic changes, but 1% to 3% shifts can make a considerable difference when done in depressed markets.

4. Harvest Tax Losses.

If you’re selling an investment that you recently purchased, it’s likely to be at a loss — and that’s not such a bad thing. Leveraging investment losses for tax deductions, or tax-loss harvesting, is a helpful strategy, with losses on short-term investments (securities held for less than 12 months) applied against the tax hit from short-term investment gains and losses on long-term securities (held for 12 months or more) applied against long-term gains. 

Up to $3,000 in leftover losses can be used to offset other gains — and given the condition of the market, it’s possible many investors will be able to use all of that. In fact, remaining losses beyond the $3,000 cap can be carried over to the next tax year.

Anytime tax-loss harvesting is discussed, it should come with a reminder of the wash-sale rule, which says investors must wait 30 days before repurchasing the same security for the sale to be recognized as a sale and for the loss to apply.

5. Fund a 529 College Savings Plan.

Your time horizon is short to save for your child’s education or future goals, even for young parents. Now is a good time to open a tax-advantaged 529 college savings plan and/or max out the contribution if possible ($16,000 for 2022). The main advantage of a 529 plan is tax-free growth, so buying when the market levels are down is generally to your advantage.

There Is Hope for 2023

When it comes to financial planning, growth is the easiest thing to get tax advantages on, and it’s much easier to predict growth when we’re coming off all-time market highs. If history tells us anything, the market is certain to rebound — although, how long it takes to get back to previous levels is far more uncertain — so making the right moves now can help you capture that growth in a much more tax-efficient manner.

Investing requires patience, often when it doesn’t feel good to do so. History has told us that we will get back to where we were and then some. Here’s hoping that’s in 2023. 

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Waldron Private Wealth (“WPW”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from WPW. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. WPW is neither a law firm, nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of WPW’s current written disclosure Brochure discussing our advisory services and fees is available upon request or at www.waldronprivatewealth.com.