Tax Planning During Market Declines

by Michael Vaughn, CFP®

Market declines are scary. Unfortunately, they’re inevitable, but with the right perspective, you don’t need to fear them. So the next time a market decline occurs, what can you do to lessen the impact on your financial (and mental) well-being? 

The truth is, the best approach is often to wait out the crisis and give the markets time to recover. But to soften the blow, you can adjust your tax planning strategies to mitigate losses you incur and capitalize on the return to growth we have historically seen. 

Here are three “make the best of it” tax planning strategies to consider during a market decline.

Roth Conversion

A traditional IRA or other pre-tax retirement account allows you to invest more money earlier, granting more time for the investments to grow and benefit from the power of compound interest. But you’ll have to pay taxes on withdrawals from those accounts down the road, and many people believe taxes are only likely to increase as time goes on. (1)

A Roth conversion is an increasingly popular method to pay taxes on those investments while your tax burden might be lower. You can convert all or only part of a traditional IRA to a Roth IRA, but the money you convert will be taxed as income in whatever year you make the conversion. Then you’ll never have to pay taxes on it again.

A market decline may be the perfect time to take advantage of the Roth conversion opportunity. During a market decline, you can convert more of an investment for the same cost as a result of lower share prices. Plus, the future growth of the investment can now grow tax-free when the market rebounds.

Tax-Loss Harvesting

Another strategy to consider during a market decline is tax-loss harvesting, which could offer a silver lining during market declines. By deliberately selling some investments at a loss, investors can lower their tax liability on realized capital gains from assets that have performed well.

Tax-loss harvesting isn’t for everyone, and can result in some unpleasant consequences if not executed correctly. While tax-loss harvesting can be a good opportunity within a comprehensive financial plan, it should only be done with the advice of an experienced professional who can help you determine if the strategy will truly benefit your unique situation.

Contribution Maximization

Finally, a market downturn is a good opportunity to maximize your contributions to retirement accounts if possible. This may sound counterintuitive, but let me explain. The key to long-term investing is to buy low and sell high. We don’t recommend trying to “time the market,” but when stocks are low, you want to be buying. So keep purchasing stocks when they’re priced low.

If you’re still working and contributing to a 401(k) or 403(b), consider maximizing your contributions at the end of a low-performing year. Maximizing your contributions means you’re purchasing shares at a low price, keeping more of your hard-earned money for yourself, and lowering your taxable income. 

How We Can Help

Working with a trusted financial partner like Pinnacle Family Advisors can help you optimize financial opportunities you haven’t known about before, especially during times of volatility. But don’t wait until the next market decline to start working with a financial advisor. 

Begin the relationship now so you can plan ahead, prepare, and prevent a crisis from causing you undue stress. Schedule your complimentary introductory meeting with us today by emailing [email protected], calling (417) 351-2942, or using my online calendar.

About Michael

Michael Vaughn is a Certified Financial Planner™ (CFP®) and Vice President at Pinnacle Financial Advisors (PFA) with 20 years of industry experience. Before joining the PFA family, he served clients with investment management and retirement planning at The Mutual Fund Store for 14 years. Michael graduated from Missouri State University with a bachelor’s degree in business administration and management and earned his CFP® designation in 2004. He also served 20 years in the Missouri National Guard, retiring in 2007 as a Major. He currently volunteers on the board of directors for Good Dads and Fellowship of Christian Athletes. Michael is married to Lori and they have two daughters. To learn more about Michael, connect with him on LinkedIn.