Individual Retirement Accounts (IRAs) are popular tax-advantaged retirement savings vehicles offering both traditional and Roth options for investors to put money away for retirement. Although investors should aim to grow their IRA over time, there may come times where assets within it decrease in value; when this occurs there may be the option of “IRA loss harvesting”, which requires deeper exploration to understand both benefits and considerations associated with it.
What Is Loss Harvesting?
Loss harvesting refers to an investment strategy of selling securities which have experienced losses to offset capital gains tax liabilities and, potentially, up to $3,000 of ordinary income tax liability and reduce one’s taxable income. By realizing and “harvesting” losses this way, investors may reduce taxable income significantly and potentially offset up to three tax liabilities at one time by offsetting losses against gains (called harvesting them or “harvesting them”).
However, it’s essential to recognize that loss harvesting typically applies only to taxable accounts; since IRAs are tax-advantaged accounts without capital gains tax implications like traditional brokerage accounts do – and therefore harvesting is usually unnecessary – the question arises of whether loss harvesting makes any sense in such circumstances?
An Overview of IRA Loss Harvesting Strategies
Capital Gains Taxes Inside an IRA: Unlike their brokerage counterparts, IRAs do not incur capital gains taxes when assets sold at a profit are sold off within their boundaries. On the flipside, assets sold for less than expected don’t provide tax savings from loss harvesting as such a practice isn’t directly applicable in an IRA account.
Under certain conditions, investors may have the chance to deduct their IRA contributions on their income tax returns. If you made nondeductible contributions to a traditional IRA that have since declined below their total nondeductible contribution total amount, withdrawing all or part of it or switching it over to Roth would give rise to loss claims; but taking this route requires careful record-keeping and professional guidance for best results.
Rebalancing and Investment Strategy: Although loss harvesting in an IRA may offer limited tax benefits, realizing losses can still serve a useful function of rebalancing. For instance, if a particular asset class underperformed and is no longer appropriate to your strategy, realizing losses by selling and reinvested proceeds could help achieve your desired asset allocation goals.
Considerations and Caveats in Mind
Avoid Wash Sale Rules: Loss harvesters must also keep in mind the Wash Sale Rule when conducting loss harvesting, which prohibits investors from claiming losses on sales if they purchase an “essentially identical” security within 30 days before or after selling one – such purchases could occur both within taxable accounts as well as IRAs; any of which would violate this tax benefit for loss harvesting activities.
Opportunity Cost: When selling assets solely to harvest losses, this puts yourself out of position if and when they start showing signs of recovery shortly thereafter – you could miss out on substantial potential gains that would arise as a result.
Professional Guidance: Given the complex issues surrounding traditional IRAs with nondeductible contributions and potential deductions from them, seeking expert guidance before making decisions should always be your top priority. Consultations is recommended.
While loss harvesting may be common among taxable brokerage accounts, its application within an individual retirement account (IRA) can be more nuanced and limited. Before undertaking such strategies for personal IRA accounts, it’s critical that investors understand both tax and investment implications, along with professional guidance to make sure any moves make sense with overall financial goals.