Tax-Loss Harvesting: Offsetting Gains Before Retiring

Introduction

For investors approaching retirement, managing tax liability is essential to preserving wealth. One effective year-end strategy is tax-loss harvesting—a technique that allows you to offset capital gains with investment losses, potentially lowering your taxable income. This can be particularly beneficial if you’re on the cusp of retirement, as it helps maximize the value of your portfolio while reducing tax burdens.

What is Tax-Loss Harvesting?

Tax-loss harvesting involves selling investments at a loss to offset capital gains from profitable sales. The losses you realize can be used to reduce capital gains tax on other investments, and if losses exceed gains, you can apply up to $3,000 of losses annually to offset ordinary income. Unused losses can even carry forward to future years, providing long-term tax benefits.

Why It’s Important for Pre-Retirees

As retirement nears, it’s crucial to protect every dollar, and minimizing taxes is one way to ensure your portfolio lasts. By harvesting losses, you can strategically reduce capital gains tax, freeing up more resources for retirement expenses. This can be especially helpful if you expect to draw down taxable accounts during retirement, as it may reduce future capital gains liability.

How to Execute Tax-Loss Harvesting

1. Identify Underperforming Investments: Review your portfolio for investments that are currently in a loss position. These can be individual stocks, bonds, ETFs, or mutual funds.
2. Match Losses to Gains: If you’ve sold investments at a gain earlier in the year, selling assets at a loss can offset those gains dollar-for-dollar.
3. Consider the Wash-Sale Rule: Be cautious of the IRS wash-sale rule, which prevents you from repurchasing the same or a substantially identical security within 30 days before or after the sale. Violating this rule will disallow the tax loss.
4. Work with a Financial Professional: Tax-loss harvesting can be complex, especially if your portfolio includes a mix of assets across different accounts. Consulting a financial advisor can help ensure you maximize this strategy without running afoul of tax rules.

Key Benefits of Tax-Loss Harvesting

• Offset Capital Gains: Reduce taxes on capital gains from profitable investments.
• Lower Ordinary Income Taxes: Apply up to $3,000 of excess losses to reduce ordinary income annually.
• Carry Forward Losses: Use losses that exceed gains in future tax years, potentially lowering taxes for years to come.

Is Tax-Loss Harvesting Right for You?

This strategy is particularly effective for investors with taxable brokerage accounts who expect to see capital gains. However, it’s not ideal for everyone. If you’re only investing in tax-deferred or tax-free accounts (like IRAs or Roth IRAs), tax-loss harvesting won’t provide benefits, as gains in these accounts aren’t taxed.

Conclusion

Tax-loss harvesting can be a valuable tool to reduce your tax burden, especially in the years leading up to retirement. By offsetting gains and minimizing tax liabilities, you can make the most of your investment portfolio and position yourself for a financially secure retirement. As with any tax strategy, it’s best to consult with a financial advisor or tax professional to ensure you’re maximizing the benefits within the guidelines of current tax laws.