Weighing the impact of tax loss harvesting on long-term saving goals
11/08/2021
Joel Ryzowy
Mallika Saran
Katya Chegaeva
Leonid Kogan
Shu Wang
Ravi Pagaria
John Bilton
Katherine Roy
Jed Laskowitz
Key Points
- Higher taxes seem likely in the wake of a major boost in fiscal stimulus.
- To address the investment implications of higher taxes, investors can use active tax management - specifically, harvesting unrealized losses.
- Our analysis simulates the experiences of three personas as they invest from age 50 to retirement at age 65. Active tax management delivers significant benefits.
There’s no getting around it. Higher taxes seem likely in the wake of a major boost in fiscal stimulus, unleashed in response to COVID-19. Higher taxes clearly present important implications for investors and savers – especially for those with long-term savings goals and those investing for retirement.
Addressing the implications of higher taxes on investors and savers
To address these implications, investors can use active tax management, a valuable but often overlooked component of portfolio strategy.
In particular, investors can draw on established principles and tools to manage short-term tax liabilities. In this way, long-term savers properly account for the long-term tax liabilities that are due. At the same time, they take reasonable steps to manage liabilities that arise purely from short-term market moves - moves that might otherwise damage long-term, after-tax investment outcomes.
To illustrate the impact of active tax management we simulate the experiences of three personas as they invest from age 50 to retirement at age 65. We draw on these profiles to compare a tax-agnostic portfolio to a tax-managed portfolio.
One principle is quite clear. Active tax management - specifically, systematically harvesting unrealized losses - can offer significant benefits to investors holding taxable accounts. But while tax loss harvesting is generally well-understood, many investors may not fully appreciate the value of doing it in a systematic and deliberate fashion over an extended period of time.
Quantifying the benefits of active tax management
For the three personas, we calculated the total tax savings from active tax management. The median potential tax savings ranged from ~28bps–51bps. With the expected return for a 60/40 portfolio around 4%, that’s a meaningful boost.
We also calculated total losses carried forward (TLCF). These are the cumulative losses harvested net of the capital gains that were offset. Essentially, TLCF is a “bank” of harvested losses that can be used to help offset future tax liabilities associated with capital gains.
On average, our three savers had accumulated TLCF that represented about 4%-7% of the portfolio value at age 65. The TLCF at age 65 for the tax-managed portfolio is about 2.5x that of the tax-agnostic portfolio.
Using active tax management as a countercyclical tool
As recent volatility reminds investors that markets go down as well as up, it’s worth noting that tax loss harvesting can be a useful countercyclical tool. That’s because the opportunities to harvest losses tend to increase when market performance is poor. In our analysis of our three personas, tax savings benefits increase as market returns become more negative. In other words, long-term savers can get the welcome benefit of future tax offsets during a period of unwelcome market losses.
The 26th annual edition explores how the legacy of the pandemic – limited economic scarring but enduring policy choices – will affect the next cycle. Despite low return expectations in public markets, we think investors can find ample risk premia to harvest if they are prepared to look beyond traditional asset classes.