At the end of each year it's the same process. We scour everything in our client's taxable accounts to see if there is anything with a loss.
This year we're not finding much. Some real estate funds, closed-end funds that transferred in from a client's account with a former adviser, and a few bond funds.
So what do we do with these losses? We try to use them for tax planning, of course.
Harvesting losses by exchanging one fund or investment for an almost identical fund or investment allows you to realize the loss for tax purposes while maintaining your investment allocation and exposure to future gains.
You can learn how it works and why you might do it in How to Realize a Capital Loss for Tax Reasons.
The last few years, since the initiation of the 0% capital gains tax rate for those that fall in the 15% tax brackets, we also look for opportunities to harvest capital gains. Sometimes we can realize just enough gain to fill up a client's 15% bracket and by doing so the client pays no tax on the capital gain. Pretty cool.
This type of tax planning takes work. It takes pretty much all our time for most of the month of December. By diligently doing it each year, we save people money. And that's what they pay us for.
You can do your own tax planning. I explain how in 3 Ways to Do Your Year-End Tax Planning.
This question came in about a month ago, and brings up some excellent points about 401k loans and how they work.
My questions regarding a 401K loan have to do with the ongoing valuation of your account after a loan has been made. Let's say I have a $100K balance in my 401k. Let's say I borrow $50K, repayable over 5 years.
1. What will the initial and follow on quarterly statements look like? Will the balance be shown at $100K or $50K with a loan of $50K?
2. What will happen to the account balance, as far as earnings go? Will the fund's rate of return be applied to the $100K or the $50K?
3. What would happen to the account balance, as far as losses go? If there is a total loss because the fund failed, would the loss be $50K with a $50K outstanding loan, or would the loss be $100K with a $50K outstanding loan?"
"Hello 401k loan inquirer,
Here's the thing about a 401k loan - you have borrowed the money from yourself. The custodian or 401k provider is not lending you anything. Below are the answers to your questions.
- Each 401k provider reports in their own way. Technically the 401k loan you took is a receivable to your 401k account. For example if you made a loan to someone, the amount owed to you is an asset on your net worth statement, just as an account receivable is an asset to a business. With a 401k loan you owe money to your 401k account, so as far as your account is concerned the loan is an asset to the account while being a liability to you personally. Unfortunately this makes it confusing and there doesn't seem to be agreement in how the loans are reported. I have seen plan providers report the balance minus the outstanding loan and then list the loan separately with a footnote that tells you the loan amount is not included in the total. I have also seen statements where they started with a net balance, then added in the outstanding loan to give you a total vested value that did include the loan balance. I'm not sure how your 401k plan provider would report it.
- No, the fund's rate of return is not applied to the loan balance, so in this case investment returns only apply to the $50k that is still invested. The amount you borrowed is NOT invested in anything. You owe it back at an interest rate that is determined by your 401k plan rules. Think of the loan as note receivable with a pre-determined interest rate. The loan to you is the investment.
- The gains and losses apply only to the $50k that is invested. With a margin loan, you can lose more money than you have, but with a 401k loan you are not actually borrowing against invested funds. Instead you are making a withdrawal by selling investments, but it is called a loan so you can repay it and thus avoid the income taxes and penalties that would otherwise be associated with a withdrawal.
Learn more in 7 Things to Know About 401k Loans.
"I have been a subscriber to your newsletter and find it very helpful. My wife and I currently have a Simple IRA, a Traditional IRA, 3 Sep IRA's and a 401 (k) Sep. I would like to put these all into one brokerage account so they would be easier to manage. My question is, can I do this, especially with the Simple IRA? I'm 64 and thinking ahead before I retire at 66. Thank you for your time."
"Hi too many baskets,
I like the way you are thinking. Consolidating accounts as you near retirement has numerous advantages.
You cannot consolidate accounts with your spouse, but you should be able to get to the point of having one IRA for you and one for your wife.
You would work with your financial institution to rollover or transfer account balances into one Traditional IRA for you (you could likely use the one you already have) and one for your wife.
With your SIMPLE IRAs you have two considerations. First, is it still an active plan that you contribute to? If so, you'll need to keep it open until you are ready to terminate the plan. Second, you must have had the plan for over 2 years. If you have not had the plan for over two years do NOT attempt to consolidate or transfer this until you have met the two year requirement. There is an extra penalty tax for SIMPLE withdrawals if made in the first two years after starting participation in the plan. You do not want to risk incurring this penalty.
With your SEP 401k plan, is it still an active plan? If so, you will need to keep it open until you are ready to terminate the plan.
If you will not be making additional contributions to any plans other than an IRA, then you can work toward consolidating everything to one IRA for each of you. If you will still be making contributions, you will need to keep the active plan open.
Hope that helps!"
Reader question received this week...
I am a public employee and will receive a public employee pension upon retirement. I also have a QDRO that will require me to pay $2,000 / month. I know my SS benefits will be either none or greatly reduced.
Q: Will the Ex-Wife be considered as a public employee when she applies for social security benefits? If so, does the method of payment from me to her make a difference? For instance a direct payment from me to her, verses a payment from the pension fund administer. And would I have a choice in that?
Q: When I eventually make QDRO payments, are those payments tax deductible by me?
Any information that you can supply will be appreciated."
Here's my answer...
"First, I must qualify my answer by saying that no part of my answer should be considered legal or tax advice. Your question has numerous parts which would need to be verified by an attorney, a tax professional, and the Social Security office.
However, let me tell you what I think the answers are.
When funds are paid by a QDRO (Qualified Domestic Relations Order) they are paid directly from the plan administrator or custodian to the ex-spouse. This would mean the $2,000 a month would be taxable income to your ex-wife and it would have no impact on your tax return. This would be the preferred structure. I do not know if you have a choice. If you do, I would think you would want the plan administrator to handle it. A QDRO is a court order, so the plan administrator must follow its terms and the nature of a QDRO allows tax deferred accounts or payments to be given to an ex with them taking on the tax consequences. A QDRO payment is different than alimony. Alimony paid is tax deductible to the person paying it, and is considered taxable income to the person receiving it.
As your ex-wife would be receiving a pension from benefits not covered by Social Security tax withholding, she may be subject to two provisions of Social Security that have the potential to reduce her Social Security benefits: the Windfall Elimination Provision (WEP) and/or Government Pension Offset (GPO). However, with WEP there is a substantial earnings test, so even if WEP applied to her, if she has been in the private sector most of her life I would think she would have enough earnings that she would receive her full Social Security benefits. GPO affects spousal or survivor benefits so it could affect any potential widow/widower benefit or spousal benefit that she may be eligible for based on your earnings record. These would be questions for a senior person at the Social Security office to address as to the final answers.
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