It's That Time of Year Again

As we march headlong toward the end of another eventful year, let’s look at some important calendar-based financial considerations. Now is a great time to do so because it’s late enough in the year to hear the clock ticking, but not so late that you don’t have time to act.

We’ll look at generating cash in a non-retirement account, maximizing retirement savings, RMDs and gifting, and a few more. I’m going to break this list up over the next few weeks.

Before we get into the first installment, here are some questions to ponder about your financial life so far in 2021. Any “yes” answers are topics to drill down on because there could be planning, investing, or tax issues to consider.

• Have you had any big income changes this year? Maybe you switched jobs, downshifted to part-time, or even retired? Have you started or closed a business?
• Any large expenses on the horizon?
• Have you sold investments or other assets for what you consider to be a large gain or loss?
• Have you inherited any money or other assets?
• What’s your financial outlook for next year? Does it include any of the above?

Okay, let’s look at generating cash in your non-retirement account. This question comes up throughout the year but takes on added significance as we edge closer to year-end. The reason has to do with our tax code and the calendar. Some things carry over until tax time, such as IRA contributions made for the year prior, but most tax issues have a distinct deadline as the year turns over.

We’re now in the best season (November, December, and January) performance-wise for stocks, so you can look at trimming them back for spending cash during a strong market. Or, depending on the makeup of your portfolio, you could also trim back bonds a bit. Or both!

Ideally you have a structure in place that allows you to monitor how much your investments have grown relative to others. It’s counterintuitive, but your best candidates for trimming are likely your best performers. Maybe you have some energy-related or real estate investments that have done well, or perhaps a broad stock market index fund that you could trim. The latter is likely up around 24% this year and energy and real estate could be up 40+%.

As I’ve mentioned before, this trimming, or rebalancing, is important to the long-term health of your portfolio. Combining this with generating spending cash makes all the sense in the world.

But as you’re likely aware, you’ll pay taxes to the Feds and probably the state too, on your net realized capital gains when you sell investments in a non-retirement account. That’s kind of a mouthful, but you can make this work for you if you understand the basics.

The cool part about capital gains taxes, if I could even think such a thing, is that you’re just taxed on what you gain – hence the name. The amount you invested and certain expenses associated with it is known as your cost basis and isn’t taxed.

Here’s a simplified example of how this works.

Let’s say you need $10,000 and have the following investments:

$50,000 of Total Stock Market Index Fund that you bought for $20,000

$50,000 of Total Bond Market Index Fund that you bought for $52,000

Since your cost basis isn’t taxable, only $6,000 of the $10,000 you get from selling some of the stock fund would be taxed as a capital gain. This assumes that you only made one purchase at least a year ago. Maybe you’ve made multiple buys over the years? Each buy has its own cost basis, and you can be choosy when deciding which to sell. Try to avoid selling shares owned for less than a year because these short-term gains are taxed as ordinary income, likely higher than the federal capital gains rate of 15%.

But what about the losses in the bond fund? The same concept applies, just in reverse. If you also sell shares of the bond fund you can subtract those losses from the stock fund gains, lowering your net gain to $4,000. Or you could simply sell shares of the bond fund, generate the cash you need with no taxable gain, and let the stocks ride. Not to overcomplicate things, but you have a number of options, especially if you also have retirement accounts to rebalance in.

Gains and losses are calculated per share, so you’ll need to sell all of the bond fund to take advantage of the $2,000 loss. This isn’t a dealbreaker because you can swap your remaining sale proceeds from selling the bond fund for something similar, maybe another bond index fund or a low cost actively managed fund. In other words, you can’t simply sell your fund at a loss and then immediately buy it back. That would be too easy. You have to wait at least a month or risk invalidating the loss by triggering a so-called wash sale. Avoid this like the plague.

Fortunately cost basis data is mostly kept track of by your brokerage firm. Regulations on this changed around 2010 and your firm may not have data for what you owned prior – you can log in and check or call and ask about it. This is important because you’ll want nice clean data documenting your buying and selling come tax time.

Assuming these are the only transactions you make all year, the $4,000 of net gain goes onto your tax return where it can impact your tax bracket, your Medicare premiums, and other areas that could lead to higher taxes than anticipated. Now, taxes on $4,000 might not break the bank but start adding zeroes and taxes can get crazy awful fast. It might also be possible to pay no federal capital gains taxes if your income is low enough. Best do some basic planning on your own with the tax tables online or, ideally, work with your tax advisor (or even your humble financial planner) to get a better gauge on all this.

Have questions? Ask me. I can help.