Generating Cash from Your Portfolio

Last week we took a break from our list of year-end considerations to review the third quarter. Now let’s get back into it by looking at generating cash from your portfolio and how to think about gains and losses as we approach year-end.

As with other topics we’ve covered, taking income from your portfolio and realizing gains and losses are specific to the calendar year. This is something you can leverage if you know how. Here’s an example of what I’m referring to.

Let’s say you have three types of accounts: a brokerage account, a Traditional IRA, and a Roth IRA. You have an upcoming expense or maybe you need regular cash infusions to help cover expenses during retirement. Just to pick a number, let’s assume your cash need is $20,000.

Which account should you take that money from? To me, the correct answer is mostly about taxes and that creates a basic order of distribution.

Generally, you want to draw from your brokerage account first (assuming you’ve spent your cash savings down beyond acceptable levels). Even though earning dividends and interest and selling investments is taxable in this account type each year, you have cost basis and preferential tax treatment. We’ll discuss this further in a moment.

The second account you’d pull from is your Traditional IRA (or workplace plan) because every dollar you withdraw is taxed as ordinary income and might have a penalty if you withdraw too early. This could mean paying at least several percentage points of extra income tax on every dollar withdrawn versus taking the same dollar from your brokerage account. You’re forced to start withdrawing at age 73, as we’ve discussed recently, but otherwise you’ll want to plan carefully.

Next on the list is pulling from cash value life insurance or perhaps a non-qualified annuity. Doing so has additional complications and considerations but it’s possible.

The last account type you’d pull from is usually going to be your Roth IRA. The reason is that personal Roth accounts (versus inherited Roths) don’t have RMDs and, at least in theory, can be left to grow tax free for your lifetime. That’s something to leverage as much as possible.

So there’s our basic order of distribution. Here are some considerations when looking to generate your $20,000:

When do you need to spend this money? Look ahead a year or so and set aside cash for known expenses. Maybe it’s a new roof, car, extended vacation, or tuition payments outside of 529 plans. You should use this opportunity to rebalance your portfolio a bit and use money market funds or bank CDs as placeholders. In other words, get this money out of risky long-term investments and into something safe because you know you’re going to spend it.

What do capital gains and losses look like in your brokerage account? This year has been good for stocks and bonds have held up okay. This means you may not have unrealized losses (“paper” losses that don’t matter for tax purposes until you sell) when you look at your gain and loss information on your statement or on your custodian’s website. Still, you should check because I try to sell losses first in most situations. Let’s say you have $10,000 of market value in a bond fund that’s about even in terms of its unrealized gain. If so, that’s probably the first investment to sell to generate cash.

Okay, so where to get the next $10,000? Look at your stocks and sell from your best performer. That might be a broad market fund or maybe a sector fund investing in tech stocks, for example. I’m usually thinking about that when I review gain and loss information because trimming your best performers is a simple way to rebalance a bit. Maybe your tech fund has a market value of $10,000 but your cost basis is $3,000 for an unrealized gain of $7,000. If you sold the whole position this year the $7,000 of gain would be added to your 2024 tax return as a capital gain.

Have you realized gains or losses this year? Look at your history and double check. Gains stack on top of each other while losses offset gains and you’ll pay tax based on how this nets out.

Do you have losses that are carrying forward from a prior year? This is shown on Schedule D within your prior year’s tax return. If so, those losses could help offset the gain you’re generating this year.

Realizing capital gains in a brokerage account is taxable but at a preferential rate. Most taxpayers pay a federal capital gains tax rate of 15%. (California taxes this as ordinary income.) That’s lower than the middle brackets of 22% and 24%, for example. Additionally, people in the 10% and 12% tax brackets often don’t have to pay capital gains taxes.

A few quick words about cost basis in an IRA; simply put, it doesn’t matter for tax purposes in most cases.

Consider withdrawing from multiple account types based on your tax situation. This gets more important as your cash need grows. For example, maybe you need to withdraw $50,000 and the $20,000 above is all you have in your brokerage account. You’d then look to your Traditional IRA for the other $30,000. Since that’s all taxable as income, have your tax advisor or humble financial planner run a projection to determine how the capital gain and extra ordinary income would impact your tax situation. It might be advisable to take some of the cash from your Roth. Or you could take some from your Traditional IRA this tax year and the rest in January, straddling tax years.

In short, you have options for generating cash when you have multiple account types, so try to use them!

Have questions? Ask us. We can help.