I have been hovering my pointer finger over the unsubscribe button on my Marketwatch emails for the past several weeks.
Why?
I keep getting this ugly subject line: XYZ hits its 52-week low at “blah-blah-blah.”
When you’ve been preaching the gospel of index funds for years, and all of a sudden down down down they go.
What the heck?
Who wants all that ugly negativity in their lives?
You see, XYZ is an index fund stock ticker that millions, not just me, are invested in.
It’s very popular, but not lately.
Is this a problem?
It depends.
If you were about to cash some of it out to buy an adult toy, it’s a problem because you’re going to get less money than you would have 2 months ago for the same number of shares.
If this is your current situation, may I suggest placing a limit order for the price you WANT to sell at, set it for GTC (good ‘til canceled), and hang in there for the upswing.
Now, if you don’t need cash and can afford to let it ride you don’t have a problem at all.
Because the rise and fall of the value of your investment is unrealized.
By that we mean, you don’t have a transactional event.
I can promise you that at some point in the future, be it soon or a couple of years down the road, it will go back up.
Also, without a transactional event you’re also missing something else even better, for your sake:
A taxable event.
If you’ve ever cashed out part of a 401k with equities in the portfolio you’ve seen a big long list of stock sales the following tax season under the heading 1099-B
You have a cost basis, a proceeds entry, and a date of sale.
If you have a cost basis of $1,000 and sell that stock for proceeds of $1,400? You have a taxable event on JUST the $400 gain, the amount of money you made.
Plus, if that list has losses, they balance out against the gains.
So, let’s talk about the considerations if you absolutely have to cash out of your IRA or 401k early because of whatever, and you’re under 59 ½ years old.
You will pay a 10% penalty on top of taxation of the withdrawal as income, and you absolutely should make an estimated tax payment even if you work a W2 wage earner position.
There are some exceptions such as medical care, 1st time homebuyer, tuition, and a few others, but generally you need to allow for 10% of the amount you’re taking PLUS the capital gains rate on the amount.
If you’re “average,” and your long-term capital gains rate is 15%, then in our previous example you will pay $100 tax.
15% capital gains tax + 10% penalty on $400 = $100.
Now, $100 isn’t much at tax time, but if you add a zero to all the numbers that $1,000 of tax WILL put you into underpayment-penalty country.
Go online to IRS Direct Pay, choose Estimated Tax Payment, and follow the prompts. Then, save your receipt, and make sure it makes it onto your 1040 for the year next tax season.
Now, I’m going to make another suggestion, and I really mean this because it’s what I and my family are doing, okay?
Hunker down, and wait for the storm to pass. Don’t sell low, even though that does technically reduce your gain and hence the tax.
You’re not losing money until you succumb to fear and sell low, so don’t do it!
I understand if you don’t have any other choice, but please make sure you’ve exhausted all other possible options.
I know that this has been on the more personal side of 1040 taxes, but quite a few of my folks, and quite a few of you others, have self-administered individual 401k’s in your business.
You’ve figured out you can quadruple your Roth investments over the $6,000 they allow over the course of a year for an IRA, and so it’s important to know that selling has a cost no matter when you do it.
What you should be thinking about doing is withdrawing the amount you want PLUS the sufficient amount to make a tax payment on the withdrawal. As a side benefit, it will insert some austere reality into the actual cost effect of the sale.
Let’s say you need $10,000 early withdrawal from your IRA, and you know you’re in the 15% capital gains bracket.
Subtract the 15 + 10% from 100% to get 75%. Then divide (not multiply) $10,000 by .75, to get $13,333.
When you pay one-fourth to estimated taxes you’re left with the $10,000 you need.
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