Manufacturing Tax Deferral and Reducing Social Security Taxes

Watching the national news might lead a person to think we can’t seem to agree on anything anymore. But that’s not true! Finding common ground around tax time each year is easy. It seems that every one of us, regardless of career, demographics, or socio-economic status, is trying to minimize our income tax bill. Hopefully even to the point where we get a healthy refund!

If you’re one of the multitudes wanting to lower your taxes, then you should consider a strategy called Tax Loss Harvesting+™ (TLH+™). The basic idea of tax loss harvesting is simply selling a security that’s experienced a loss and then replacing it with a similar asset. “The strategy has two benefits: it allows the investor to “harvest” a valuable loss, and it keeps the portfolio balanced at the desired allocation.”[1]

The “harvest” can produce significant tax deferral benefits inside a taxable account. If you still have plenty of years ahead to invest, then the process will manufacture tax deferral may help accrue and compound greater wealth. If “assuming a conservative growth rate of 5% over a 10-year period, a dollar of tax deferred would be worth $1.63. Even after belatedly parting with the dollar, and paying tax on the $0.63 of growth, you’re ahead.”[2]

Market volatility accentuates the ability further of a good “harvest.” The well-regarded CFA® Institute published a white paper on the subject stating, “The more volatile the stocks, the more up and down you can get. So, you have more opportunity for tax-loss harvesting.”[3]

However, the strategy can also be fantastic for senior citizens who are drawing on their Social Security benefits.[4] First, seniors have reached an age where they often want less risk in their portfolio. Executing a TLH+™ strategy does not increase risk exposure![5] Second, many people do not realize that they may have to pay taxes on their Social Security checks until after they begin receiving benefits. That is an annoying moment to say the least! Effective use of TLH+™ can reduce a senior’s provisional income and therefore potentially reduce or eliminate Social Security taxation.

If you’re worried about market volatility or want to learn more about reducing your Social Security taxes, click here:

Does It Work in Real Life?

It depends on who you have performing the strategy for you. Whatever type of an investor you are though, whether old or young, seasoned or untested, it is indispensable to always assess the investments you own and why you own them.

Then the next steps in a tax loss harvesting strategy are to “identify investments that have lost value, and then consider the sale of some portion of those holdings to offset existing realized gains. And to do this while being careful not to stray from your target investment mix and diversification strategy.”[6]

This intersection is one of the places the strategy gets tricky. To do it right, “you must identify specific lots of shares to sell. And since your investment company reports information on your gains and losses on covered securities to the IRS, it's important that everyone's on the same page about which shares are being sold.”[7]

Specifically, there are two colossal operational headaches with tax loss harvesting. First, “How does the investor calculate the net present value of the tax deduction and the transaction costs when the recapture is uncertain?”[8] Second, “How does the investor know when to trigger a loss recognition? That is, how does the investor know when the share is trading low enough?”[9]

Vanguard further highlights the impediments by affirming, “Potential issues to be aware of include the need to further rebalance a portfolio, complications of dividend distributions, and administrative hassle or transaction fees.”[10]

Rarely does a do-it-yourself investor have the expertise to make such consistent identifications. Likewise, a CPA would never have the time to literally make these calculations for a client on a daily basis as is required.

The Solution

Enter ONE Advisory Partners. We use TLH+™ for clients which specifically addresses each of the previous concerns. This solution protects our clients from cash drag, the wash sale rule, and disallowed losses. Our clients also benefit from the automatic rebalancing across all asset classes. “This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and higher tax alpha.”[11]

The following chart shows the detailed additional wealth created by using TLH+™ by back-testing results for the years 2000-2013.

Additional After-Tax Returns with Tax Loss Harvesting+

2000-2013

The chart demonstrates that the results are exponentially better than using rudimentary algorithms or manual calculations. Especially when considering the strategy is implemented at no additional cost to the investor.[12]

One of the paramount issues in financial planning is identifying client goals. As advisors we never want to let tax savings destabilize a client’s investing goals. Our strategy of everyday reexamination through TLH+™, keeps investments aligned with aims and that is the intelligent approach.[13]

Don’t miss out! Click here to contact a ONE Advisory Partners CFP® professional and bring this innovative strategy to your portfolio!

[1] https://www.betterment.com/resources/research/tax-loss-harvesting-white-paper/

[2] Ibid.

[3] https://www.cfapubs.org/doi/pdf/10.2469/cp.v2005.n5.3518

[4] https://www.nerdwallet.com/blog/investing/taxloss-harvesting-investment-losses/

[5] https://www.betterment.com/resources/research/tax-loss-harvesting-white-paper/

[6] https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting

[7] https://investor.vanguard.com/investing/taxes/offset-gains-loss-harvesting

[8] https://www.cfapubs.org/doi/pdf/10.2469/cp.v2005.n5.3518

[9] Ibid.

[10] https://personal.vanguard.com/pdf/s802.pdf

[11] https://www.betterment.com/resources/research/tax-loss-harvesting-white-paper/

[12] Ibid.

[13] https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting

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