Strategies for losses in your IRA
We hope that our investments will produce profitable returns.
Yet, investments sometimes lose value. When those investments
are held inside an IRA the losses can seem perplexing. In nonIRA brokerage accounts taxes are not deferred so losses on
investments can be included on your tax return. However,
losses on investments in IRAs can be claimed only if certain
requirements are met.
When thinking through a strategy for losses in your IRAs, know
that any loss taken will not be a capital loss and cannot be used
to offset gains, nor can it be carried over to future years. Rather,
an IRA loss is considered a miscellaneous itemized deduction
that goes on Schedule-A of Form 1040. The loss counts only if the
total amount of these deductions exceeds 2% of you MAGI.
While you may be able to claim a loss on your IRAs, you must
distribute the entire balance from all your IRAs of the same type.
That means, if the loss occurred in a Traditional, SEP, or SIMPLE
IRA, you must withdraw the balances from all your Traditional,
SEP, and SIMPLE IRAs. (These three will collectively be referred
to as Traditional IRAs in the rest of this piece). Similarly, if the
loss occurred in a Roth IRA, you must empty all your Roth IRAs
in order to include the loss on your tax return.
Traditional IRA losses
You cannot realize a loss for funds you have yet to pay taxes
on. So, if you have after-tax amounts (basis) in your Traditional
IRA you may be able to take advantage of this loss provision.
You must take full distribution of all of your Traditional IRAs
and if the total distribution is less than your after-tax basis, you
might be able to claim the loss. You have after-tax amounts in a
Traditional IRA when you make non-deductible contributions,
have repaid reservist distributions, and/or by rolling after-tax
amounts from an employer-sponsored retirement plan.
Traditional IRA loss example: Amanda made a
Traditional IRA contribution of $5,500 in March.
She was not eligible for a deduction because she
is covered by an employer-sponsored retirement
plan and her income was above the deductibility
limit. Her IRA balance in October was $3,500 and she took full
distribution from this IRA, which is her only one. She might
be able to take a $2,000 loss on her tax return. It is important
to note that if Amanda had been able to deduct her $5,500
contribution, she would not be able to take a loss. What else could
Amanda have done? Amanda could have chosen to keep her
non-deductible contribution in her Traditional IRA because she
was eligible to make the contribution. She could also convert that
amount to a Roth IRA. Or she might recharacterize, if eligible, as
a Roth contribution.
Roth conversion
One strategy to consider if your Traditional IRA has
experienced a decline in value is converting to a Roth IRA.
Through a conversion investors may achieve a long-term
investment advantage. Converting allows you to reposition your
current tax-deferred Traditional IRA to a potentially tax-free
Roth IRA* by paying federal and possibly state income tax (but
without the 10% IRS penalty tax) on the taxable amount of the
conversion. Due to the lower balance in your Traditional IRA, the
tax bill may be far less than it might be if you enjoy a period of
positive market returns.
The IRS has clarified the rules for allocating before-tax and
after-tax eligible non-Roth 401(k), 403(b), or governmental 457
plan distributions made to more than one destination, such as a
Roth IRA and/or the plan participant. This ruling allows you the
option to elect a direct rollover of the before-tax amounts in your
401(k) to a Traditional IRA without any tax liability and then roll
the after-tax amounts to a Roth IRA as a tax-free conversion. The
conversions can be made through a direct rollover from the plan
to the Roth IRA, or an amount can be distributed from the plan
and rolled over to the Roth IRA within 60 days.
Roth IRA loss strategies
If you’ve experienced a decline in value of your Roth IRA(s), here
are some strategies that you might wish to consider.
Claim a loss on taxes
Investors who have Roth IRAs that have lost value can consider
taking a loss. Losses can be claimed in certain situations, if all of
your Roth IRAs are completely distributed.
Roth IRA loss example: Joe converted to a Roth
IRA two years ago. His $30,000 Roth IRA is now
worth $20,000. Joe empties his one and only Roth
IRA and ends up with a $20,000 distribution, along
with a $10,000 tax loss. Joe is only 45 years old
and the Roth IRA conversion was only in effect for 2 years, so
he’ll owe a 10% penalty on the distribution. If Joe had converted
at least five years ago, he would have avoided the 10% penalty
on the converted amount under the ordering rules for a nonqualified Roth IRA distribution. Depending on Joe’s situation
this strategy may or may not be advantageous.
Recharacterize your Roth IRA conversion
Recharacterization is another option available for investors who
recently converted to a Roth IRA. If you are facing a hefty tax
bill on your conversion, but have seen your account balance
take a dip in recent months, there’s good news. You may be able
to recharacterize — or reverse — that conversion. In fact, you
don’t have to recharacterize the entire amount as you are able to
recharacterize only a portion of the conversion. If you file your
federal income taxes by the due date, usually April 15, you have
an automatic six-month extension, generally until October 15
of that tax filing year, to complete a recharacterization. If you
recharacterize after filing your taxes for the year, you may be
required to file an amended tax return. You should be aware
that the net income or loss attributable to the conversion that is
being recharacterized must also be transferred when the process
is executed and is determined according to the IRS-provided
formula.
Reconverting to a Roth IRA
If you convert to a Roth IRA and then recharacterize you may not
reconvert that amount to a Roth IRA until the later of:
• The tax year following the tax year in which you converted that
amount to a Roth IRA or
Recharacterization hypothetical
examples
Below are three hypothetical examples to better
explain if you recharacterize when you can reconvert.
• Same year recharacterization hypothetical example: John
completed a Roth conversion in February 2016 and recharacterized in July 2016. John must wait until January 1,
2017 to reconvert.
• 30-day hypothetical example: Sally completed a Roth
conversion in March 2015 and recharacterized on October 15,
2016. She is able to reconvert beginning November 14, 2016.
• End of year recharacterization hypothetical example:
Melanie converts to a Roth IRA in March of 2016. She
recharacterizes on December 21, 2016. She must wait until
January 19, 2017 to reconvert.
Talk to Wells Fargo Advisors
These strategies may be the answer to some
of your IRA concerns. However, the rules on
IRA losses are complex. We recommend that
you speak with your tax advisor before acting on any of these
strategies. If you have questions, please contact your Financial
Advisor with Wells Fargo Advisors. We are happy to work with
you and your tax advisor to determine if any of these strategies
can benefit you and your family.
With you every step of the way
Everyone has a different vision of retirement that requires a
unique financial strategy. Wells Fargo Advisors can support you
in your retirement planning process by providing the guidance
needed to make better, informed choices. We will meet with you
and help create a comprehensive plan that takes into account
your complete financial picture. Your Financial Advisor will be
with you every step of the way to monitor your progress and
adapt your plan as needed. Working together, we’ll design and
implement a retirement plan that can help you live out your
unique vision of retirement.
• The end of the 30-day period beginning on the day of the
re-characterization.
*Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free provided a Roth
account has been open for at least five years and the owner has reached age 59 ½ or meets other requirements. Both may be subject to a 10% federal tax penalty if distributions are taken prior to age 59½.
Wells Fargo Advisors does not render legal, accounting, or tax advice. Please consult your tax or legal advisors before taking any action that may have tax or legal consequences. This document was not intended or written to be used,
and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on the tax payer.
INVESTMENT AND INSURANCE PRODUCTS:
NOT FDIC INSURED
NOT BANK GUARANTEED
MAY LOSE VALUE
Please Note: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this
information is not guaranteed and is subject to change. It is based on current tax information and legislation as of March 2016. Since each investor’s situation is unique, you need to review your specific investment objectives, risk
tolerance, and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own
tax and legal advisors before taking any action that may have tax or legal consequences.
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