Taxes are one of those inevitable things in life. You earn enough money, you have to pay your fair share to the government. And especially in a year where a lot of us saw losses in our portfolio (72% of S&P 500 stocks lost value this year), figuring out how much you owe to the government can sound pretty dreadful.
But it doesn’t have to be — in fact, 2022 serves as a great opportunity to look back, learn some lessons, and apply them to the coming year. Let’s take a look at the top three lessons we can learn from 2022’s taxes.
Lesson #1: Losing money can actually be a positive
As we mentioned above, 72% of S&P 500 stocks lost value in 2022. That means that a lot of portfolios lost value with it. And while that might be disappointing, there are positives that can come with these negatives — if you know about tax-loss harvesting.
Tax-loss harvesting is when you intentionally sell investments at a loss, then deduct those losses against other taxes you owe. Since capital gains taxes owed are a sum of gains and losses, you could actually avoid paying taxes on your profits by using a tax-loss harvesting strategy.
Plus, if you end up having more losses than gains, you can deduct $3K of those losses against your regular income.
No one knows what 2023 will bring in terms of the stock market. But if you know beforehand that tax-loss harvesting is an option, you can pay closer attention to what stocks you might want to let go of when the year comes to a close. If you want to get really strategic about it, you can even get rid of a position that lost you money while rebalancing your portfolio. Or choose which particular shares of your stock you’d like to sell.
If, for example, you bought shares in January and shares in June, but the stock’s been falling all year, some platforms (like eToro!) let you sell your January shares specifically, since they would have incurred a larger loss.
Lesson #2: Your 401(k) is more than okay
In a year full of losses, you might have refrained from doing a whole lot of investing. But if you’re like many Americans, you probably didn’t stop contributions to your 401(k).
And guess what? From a tax perspective, that’s great!
The money in your 401(k) is tax-deferred, meaning you don’t pay taxes on it upfront. In fact, you don’t pay taxes on it at all, until you withdraw from your account (in most cases, during your retirement). And while most people are familiar with how a 401(k) works, what might shock you is just how impactful the numbers are.
Since income tax rates can be anywhere from 10 to 37%, using a tax-deferred account means that you can automatically invest between 10 and 37% more.
For example, if you put $1,000 in your 401(k) at an 8% annual rate for 30 years, that $1,000 could turn into $10,063. If you put that same money in a taxable account, and you’re in a 20% tax bracket, you’d only have $800 to invest. At that same growth rate, you’d have $8,050 — a $2K difference.
But there are other tax-advantaged investment vehicles out there as well — some with even more tax benefits (or just different benefits). Roth IRAs, for example, allow you to invest post-tax money, then withdraw it without having to pay taxes on your gains. That means it’s one of the few accounts where you won’t have to pay capital gains tax. (And, fun fact, if this sounds appealing — IRA cycles are different from the typical calendar year, meaning you can contribute to a traditional or Roth IRA through April 18, and it will count toward your 2022 tax year, rather than 2023.)
Or, if you want to take it to the next level, you could look into health savings accounts. They’re triple tax-advantaged, as you can invest with pre-tax money, you’re not taxed on withdrawals for medical expenses, and invested money grows tax-free. You can also use the balance for qualified health expenses, or use it as an extra retirement account. And when you’re trying to get the most out of your investments (and out of your tax practices), those savings can add up.
Lesson #3: “YOLO” may not be the best investing strategy
Yes, YOLO investing can be fun. But with the market so unpredictable over the past year, you may have learned it’s not the right strategy for you — depending on your risk tolerance and your goals.
One additional, tax-related factor you might want to consider when deciding on your strategy? The difference between your normal tax rate and the long-term capital gains tax rate.
If you hold a stock for a year or less, you have to pay your ordinary income tax rate on the gains. But if you hold that stock for longer than a year — even a year and one day — you get to enjoy the long-term capital gains rate, which can be anywhere from 10-20%, depending on your income.
While it might seem like a small thing to factor into your investing strategy, it might be an even smaller effort to apply it. The average holding period for a stock is around 10 months — just a couple of months shy of being able to keep more of your money. Being more cognisant (and less YOLO) of when you’re buying and selling stocks could save you quite a bit, come next tax season.
Starting fresh
There’s not much that can be done to change your 2022 investment taxes — but there’s plenty of time to start applying what you’ve learned to 2023. These three lessons can hopefully turn a situation you’re dreading into one that you’re — well, dreading a little less. Or at least one in which you know you’re getting the return you deserve.
*Data sourced through Bloomberg. Can be made available upon request.