In times of stress, our natural reaction is to either run for the hills, fleeing from what threatens us or to freeze and do nothing, choosing to endure and hoping to survive. The reaction is natural whether the threat is physical or financial. In periods such as the first half of 2022, with the S&P 500 recently entering bear market territory and bonds having one of the worst starts in history, investors might feel especially threatened.
Rather than reacting reflexively by fleeing or freezing, investors are better off recognizing that markets will always be subject to volatility and maintaining their focus on long-term wealth planning. Doing so requires perceiving volatility not as a threat, but rather as an opportunity.
What follows are some wealth-building moves to consider in opportunistic times like these:
Max Out Your Health Savings Account (HSA)
- For those with eligible health insurance plans, Health Savings Accounts (HSAs) that feature an investment option provide a triple tax advantage: 1) tax deductions for contributions, 2) tax-free growth, and 3) tax-free withdrawals for qualified medical expenses.
- While many use HSAs to fund current medical expenses from year-to-year, investing funds in the HSA for the long-term makes better use of the triple tax advantage if you can pay medical expenses from other available income sources.
- Investing contributions in assets with relatively lower valuations with long-term growth potential takes it a step farther. Remember also that there is no time limit on receiving reimbursement for qualified medical expenses from the HSA, so be sure to save receipts, EOBs, or invoices for medical expenses and look to reimburse yourself in the future, liquidating investments in the account when markets may be at or near highs.
- Contributions are capped at $3,650 each year for individuals and $7,300 per year for families. Catch-up contributions of $1,000 per year are available to individuals age 55 or older.
Convert a Portion of Your Tax-deferred IRAs to Roth IRAs
- In general, someone considering a Roth conversion strategy assumes that taxes will be lower at the time of conversion and higher at the time of withdrawal with the goal of minimizing lifetime taxes paid. This strategy also provides tax diversification for the withdrawal phase of life, adding a tax-free bucket to draw from in addition to tax-deferred buckets (traditional IRAs and traditional 401(k)s, for example).
- For those expecting to leave assets to their heirs, a Roth account is a more income tax efficient vehicle for transferring assets, given new rules requiring the 10-year liquidation of retirement accounts (for both traditional and Roth) for non-spouse beneficiaries.
- While liquidating stock and bond positions when markets are down may not be ideal, making a Roth conversion provides an opportunity to move assets with greater appreciation potential from a traditional IRA, where taxes will be owed on all future withdrawals, to a Roth IRA, where future qualified withdrawals are tax-free.
- Note that Roth conversions are irreversible, taxable events. Make sure you understand the impact on your taxes and the potential impact of the resulting higher Adjusted Gross Income (AGI) on future Medicare costs. Also, the efficacy of this strategy can be complicated if you already have funds in a traditional IRA.
Make Gifts to Children or Grandchildren
- Down markets may be a great time to consider gifting assets that are expected to grow over the long-term, especially if estate taxes are a concern. To start, you could maximize the annual gift exclusion amount (currently set at $16,000 per year, per person). The annual gift exclusion is the amount, indexed to inflation, that each person can gift each year without decreasing their lifetime gift and estate-tax exemption amounts.
- As an example, a couple can gift a total of $32,000 to each child this year without gift or estate-tax consequences. Beyond this, lifetime gifting, not subject to estate taxation, is $12.06 million per person, indexed to inflation, through the end of 2025 at which point the amount is expected to drop to $6.2 million per person.
Contribute to 529 College Savings Plans for the Benefit of Your Children or Grandchildren
- Contributing to a 529 college savings plan is one way to make use of the annual gift exclusion amount, as mentioned above. If you are considering contributing to, or already contribute to a 529, down markets may be opportune times to invest for long-term educational goals.
- Funds in 529s grow tax free, and withdrawals for qualifying expenses are tax free for the beneficiary. Many states provide a deduction or a tax credit for contributions up to a certain limit. Indiana, for example, provides a tax credit of 20% on up to $5,000 in contributions per year, resulting in a maximum $1,000 credit.
- The 2017 tax legislation changes also expanded eligible expenses to K-12 education at a limit of $10,000 per year per child, a change that most states have adopted.
- Even when a beneficiary’s expenses may be overfunded, it may make sense to continue contributing because 529 beneficiaries can be changed to other eligible family members, including grandchildren or great grandchildren.
Make Roth IRA Contributions on Behalf of Your Children or Grandchildren
- Consider gifting funds to your children or grandchildren to contribute to a Roth IRA. This strategy is especially relevant if you have children or grandchildren who have earned income from a summer job or are early in their careers. With decades before distributions are necessary, funds will be well positioned to grow and compound in a tax-free account.
- Contributions are currently limited to $6,000 per year and are available to those with a Modified AGI less than $144,000 in 2022.
Down markets can be threatening, but they can also present opportunities. The actions outlined above are only a few ways to take advantage of these opportunities. Before making any of these moves, however, it is essential to ensure that they are consistent with your overall wealth planning. Please consult with your wealth advisor to consider what is best for your individual situation.
DISCLAIMER: This report includes candid statements regarding wealth planning strategies and economic and market conditions; however, the views and strategies described in the piece may not be suitable to all readers and are subject to change. This information is not intended to provide and should not be relied on for accounting, legal, or tax advice. Investing in stocks involves risk, including loss of principal. Past performance is not a guarantee of future results.