Can You Harvest Losses in an IRA?

Contrary to investments held within taxable accounts, investment losses in an IRA cannot be deducted on your tax return. However, taking advantage of long-term capital loss harvesting opportunities within your retirement accounts can help minimize taxes owed while staying on course toward reaching your investment goals.

However, this strategy can have its limitations when investing in tax-advantaged accounts such as Roth IRAs.

1. Tax Deductions

Tax deductions available with an Individual Retirement Account (IRA) depend on its type, your income level and whether or not it is covered by an employer retirement plan. Traditional IRA accounts offer tax-deferred growth while withdrawals are taxed as ordinary income; Roth IRA accounts allow tax-free growth and withdrawals.

An IRA loss is used to offset capital gains and decrease an investor’s overall tax liability, helping lower taxable income while excess losses can be carried forward to offset gains in subsequent years.

Custodial fees and management fees associated with an IRA typically aren’t deductible due to being considered miscellaneous itemized deductions that fall under the 2%-of-AGI floor and alternative minimum tax provisions; consequently harvesting losses within such accounts often isn’t feasible or recommended.

2. Market Timing

Market timing often has an unfortunate reputation and research indicates it usually fails to outperform buy-and-hold strategies over longer time horizons. Successful market timing requires disciplined stock sales at both favorable and unfavorable times, which most investors find challenging. Furthermore, those prone to worrying and overthinking as well as those seeking instant gratification may find market timing impossible to be successful at.

Tax loss harvesting may be more effective in taxable accounts than retirement accounts due to contributions, withdrawals, dividend sweeps and other cash infusions that reduce portfolio basis and thus limit harvesting opportunities in future years. Tax-loss harvesting strategies depend on long-term investment goals and an investor’s ability to recognize when their portfolio has exceeded its initial targets. Harvesting losses could also be useful in anticipating changes to tax rates; for instance, high earners who anticipate moving into higher tax brackets in the future could use it to offset LTCG taxes which are currently taxed at up to 30% for high income earners.

3. Transaction Costs

No matter if you are harvesting losses in an IRA or investing through traditional, Roth or SIMPLE IRA accounts, buying and selling stocks incurs costs that vary based on the broker or platform used.

Consider this example: you realize a capital loss of $3,000 on security A when its value drops to $7,000. Immediately afterwards, you use these proceeds to invest in something more in line with your asset allocation strategy – although this reinvestment may not violate the wash sale rule, it is wise to remember that harvesting losses can present several unique obstacles and issues.

Betterment IRA/401(k) users are protected from this by TLH+, an automated system which weighs the wash sale implications of every deposit and withdrawal and automatically selects an investment with minimal wash sale implications for every replacement opportunity.

4. Long-Term Investment Goals

Be it saving for an emergency fund, buying a home, or retiring comfortably; many investment goals are long-term and take time to reach. Therefore, it is essential to maintain and reevaluate your savings strategy over the course of many years in order to reach these objectives.

Long-term investing helps protect against market fluctuations by offsetting any daily swings in value of an investment, when its value decreases, it can create a capital loss which may be used to offset gains or reduce ordinary income in the year of sale. Furthermore, excess losses can even be carried forward for use against future income in subsequent years.

Tax loss harvesting can be an effective strategy to increase investment efficiency for many investors, yet it must take into account each person’s personal tax situation before adopting this approach in an IRA or retirement account. Online calculators as well as meeting with a financial advisor may give a sense of how many deductions could potentially be generated and their effect on total tax liability.


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