4 Planning Opportunities for Volatile or Declining Markets

We have an expression in the office that we often use with clients: “We make lemonade out of lemons.” When the market is down, when things look their bleakest, when clients don’t know why they are paying you or how you will earn your value, that is when we shine.

Obviously, there are plenty of investment moves that a savvy advisor can make: tax-loss trading, selling highly appreciated stocks now that other losses are in place, buying high conviction stocks on the dip, moving money off the sidelines, rebalancing, shortening duration on bonds, and so on. Indeed, don’t forget the often overlooked strategy of paying 0% in capital gains by controlling how appreciated assets are sold (which works for couples with under $80,000 of taxable income). We should all be considering these moves at this time for all clients.

But, what about planning opportunities? How do we create opportunities there? Well, as luck would have it, there are plenty of ways that the savvy planner can demonstrate value in a declining market.

1. Full steam ahead on Roth conversions!

During the mini-market crash in December 2018, do you know what we were doing the week of Christmas? We were performing Roth conversions as the market was down -20%. The clients who listened to us (and allowed us to do it) now think we are geniuses. What a great opportunity at the time to make money for clients in one place when they were losing it somewhere else. And by the way, we performed a few Roth conversions during the week of February 24 when the market lost 10%.

We all know that Roth IRA conversions are taxed at ordinary income tax rates, so doesn’t it make sense to perform these conversions when the markets are down and when the client’s income could also be down due to depressed asset values? This is so obvious, but it bears repeating.

Review your client list and seek out all clients who are considering Roth conversions and whether the recent downturn (or future downturns) could create the opportunity that you are waiting for.

2. Consider withdrawing monthly income from traditional IRA

With asset values depressed and interest rates headed lower, client’s income is likely going down too, regardless of where they get their income from (stocks or bonds). We have previously discussed why advisors should throw out traditional withdrawal strategies (i.e., taking from the taxable accounts until depleted, and then going to traditional IRA accounts) for their high-net-worth clients. This approach creates an additional tax burden on couples once they are taking Social Security and RMDs, and that burden only grows once the widow’s penalty kicks in. And it continues to grow at death if the IRA is left to the children.

Why not consider pulling your client’s monthly withdrawals from their traditional IRA account instead of their taxable accounts in an ‘off year’? This way, you drive down the traditional IRA balance, which helps to decrease future RMDs, decreases future taxes and helps to minimize the post-mortem SECURE Act issue for the beneficiaries.

3. Consider doing some estate planning or gifting appreciated assets

Appreciated assets may have lost some of their luster (even if only temporarily). There are a variety of limitations on gifting, whether we are talking about $15,000 annually, or counting assets towards the lifetime $11.6M Federal exclusion. And although the $11.6M exclusion is generous by most standards, 12 states and the District of Columbia still have a state estate tax, and six states still have an inheritance tax, so advisors still need to be aware of where their clients live and the potential federal and state estate tax ramifications.

When we do estate planning and gifting, much of that planning is geared towards the value of the item you are gifting. Thus, gifting an asset that has depreciated will count less towards these limitations stated above, and thus you are able to leverage the exclusions to your benefit. In fact, for much of estate planning, the preferred course of action is to gift assets that are anticipated to highly appreciate, since that is the best way to leverage the limitations in your favor.

This may not come up too frequently given the size of the federal lifetime exclusion and portability, but for those clients who are still worried about a federal estate tax, or a state estate tax, you can create a lot of value by contacting the estate planning attorney and seeing if there is something that can be done with depreciated assets at this time (or in the future).

4. Don’t forget their employer retirement plan

Converting from a traditional 401(k) plan to a Roth 401(k) makes sense when markets are down. In addition, consider recommending that your client take their current after-tax contributions or make after-tax contributions to their 401(k) plan, and then immediately convert those contributions to a Roth 401(k). Not all 401(k) plans allow after-tax contributions, but if they’re allowed, and the plan also offers a Roth 401(k), then it is likely that the plan allows “in service” conversions. The tax-free growth on the entire Roth 401(k) is superior to the tax deferral of the earnings that is offered on an after-tax account.

Proceed thoughtfully

It is important to remember two things when recommending these planning strategies. First, utilizing these strategies could increase other taxes tied to AGI (such as Social Security), thus, you should understand the collateral effects. Second, utilizing one of these strategies may make it more expensive to use other strategies, such as a Roth conversion. So, make sure to understand the ramifications of these strategies by using good tax and financial planning software. And finally, identify your client’s priorities so that you can make sure you are addressing their true needs.

In the end, your clients will be thrilled that you are making money for them somewhere while they are losing money in other places. And isn’t that a great way to show your value?