Who considers a 700-point decline in the stock market a ‘good time’? Certainly not the millions of Baby Boomers on the verge of retirement with underfunded 401(k)s. And certainly not new Millennial investors. No sooner do they overcome their market wariness to venture into stocks, than they see their small holdings get smaller.
At moments like these, such as we have recently experienced with the unexpected British decision to leave the European Union, the urge to do something, rather than just standing there as a victim, can be overwhelming. But as seasoned investment advisors remind us, with each such climatic event, history shows that such pain is usually temporary. The worst thing to do with your U.S. and International equities – assuming you had a well-diversified portfolio – is to get out. (Now, if only the British public had heeded that advice…)
But let’s just say that the blow to the European economy is just the beginning of worldwide recession as some pundits predict. Suppose the uncertainty lasts for more than a news cycle or two, and blights the rest of the year, or even beyond. Does it make sense then to do absolutely nothing?
Probably not. At very least, each major market setback signals to investors that they should be evaluating and rebalancing their portfolios. Loss harvesting in taxable accounts also makes sense, though be aware that rebalancing and loss harvesting can work at odds, since the first requires trimming “winners” where the second leads to dumping “losers.” Doing either activity just based on plusses and minuses without evaluation of the quality of your holdings is not recommended.
But for those still itching to make some kind of move, consider the following financial planning strategies designed to benefit from temporarily lower asset valuations.
Doing an IRA-to-ROTH conversion
If you have been thinking about the benefits of a ROTH account, where your assets can grow tax-free for your lifetime and that of your heirs, you may want to convert some or all of your IRA assets into a ROTH. At the time of conversion, you will incur an ordinary income tax liability on the value of the assets transferred. Doing this when asset values are depressed allows you to get more of your IRA assets into a ROTH for a given tax cost.
Undoing, then redoing, an IRA-to-ROTH conversion
When stock prices fall significantly in value, relative to the recent past, a window of opportunity also opens for those who did an IRA-to ROTH conversion in the prior year or earlier in the same year when asset prices were higher. You are allowed to reverse this conversion, putting the assets moved into the ROTH back into the IRA, and thus eliminating the tax liability incurred at the time of converting. You can then move the assets returned to the IRA back into a ROTH after a 30-day waiting period. In so doing, again you will incur taxes, but because asset values have declined, the tax cost of the second conversion will be much lower. (Be sure to check the rules and deadlines for ROTH re-characterizations and subsequent conversions on www.irs.gov.)
Let’s suppose you have a block of Apple stock that you intend to give to children or grandkids, but want to keep within the annual gift tax exemption limits (currently $14,000/per year/per donee). If you make the gift at the time of a big market decline, you can get more shares of stock to your beneficiaries without incurring any gift tax liability.
Reducing the value a large estate to save estate taxes
A down stock market may benefit beneficiaries of very wealthy, recently deceased individuals whose taxable estate consists primarily of stocks. Estate executors can choose to value the estate at the time of death or at an alternate date: six months after date of death if property is not otherwise sold before, in which case the sell date determines the estate value of the disposed property. A market decline soon after the death of a wealthy individual opens the possibility of using an alternative date for estate valuation, resulting in more wealth being transferred to beneficiaries and less to the IRS.
There are, admittedly, some downsides to these “lemons to lemonade” moves. One or two are relevant only to the mega-wealthy and their beneficiaries. All require a finely tuned sense of timing and quick action. For the other 99 percent and procrastinators, the best response to a big plunge in the stock market is to do nothing. Just three days after Brexit, markets started to climb again.
So when the next crisis hits – be it Frexit or Grexit – and the urge to do something becomes overwhelming, try this: call a CFP® professional and get your own exit plan – one that is triggered by the changes in your life and circumstances, and not by all the other people running for the doors.