Portfolio , Retirement


That dreaded time of year is fast approaching. Yep, tax time. As we barrel to that dreaded time I’d thought I’d touch on an often overlooked tool for investors, tax loss harvesting. Used appropriately, it can reduce the burden of capital gain taxes in retirement and also be a great benefit if you end up passing on wealth to family upon your death.

Tax loss harvesting refers to using the losses that will occur in your portfolio over the years to reduce your present and/or your future tax bill and can even eliminate them entirely. US tax law allows you to reduce any capital gains in a given year with any capital losses up to a maximum of $3,000 in losses in a given year. Losses in excess of $3,000 can be carried over to future years indefinitely. If you end up holding a portfolio into death, your heirs receive a stepped up cost basis, thus avoiding capital gain taxes entirely. Here is a quick example.

You invested $100K  into the S&P500 at 1,400 in Dec 2006. At the end of 2008, you sold your investment when the S&P500 was at 900 for a loss of about $36K or 36%. Then you bought back into to the S&P500 in Jan 2009 at 800. On your 2008 tax return you would use the $36K in losses to offset any capital gains that year up to a max $3,000 loss. Assuming you had no other gains in the year, you take the $3K loss and carry forward the remaining $33K loss into future years that will offset any future gains.

There are a few operation details that need to be considered, in particular to avoid wash sales. All the detail and links to more info can be found here . An important point to note is that you are just deferring taxes not avoiding them. When you bought back into the index at 800, that is your new cost basis (not the old one of 1,400), which means more capital gains in the future, but that deferral is quite valuable as money today is worth more than money in the future. And of course, you can use tax loss harvesting again in the future. Markets tend to give an investor quite a few opportunities to execute such a strategy.

Tax loss harvesting can be quite valuable in retirement. Since an investor in retirement will be withdrawing, i.e. selling, some portfolio assets that most likely will have accrued significant gains, going into retirement with a large capital loss carry over could be quite beneficial in enhancing a retiree’s income. Ideally during the wealth accumulation phase of an investor’s life, an investor would take advantage of any large negative market moves to book capital losses that can be used in retirement. But even outside the ideal scenario, tax loss harvesting can still be quite beneficial even if just used in retirement.

Now, its not all the simple. A lot of the benefit from tax loss harvesting depends on the market climate the investor faces. The last 11 years have presented two great opportunities to use tax loss harvesting, the 2000 and 2008 crashes. However, investors in the 1990s had less chances. Also, if an investor has been accumulating wealth for many years, a market decline in later years may not trigger any tax loss benefits if the investor’s cost basis is very low. Thus the benefits of tax loss harvesting can be highly variable.

Taking all this into consideration, it seems to me like the best time to try and use tax loss harvesting is after major market declines like we experienced in 2000 and 2008, moves of over 2 standard deviations. Even long time investors will most likely be able to benefit from tax loss harvesting during such times and be able to defer any capital gains taxes well into the future. Every investor’s situation will be slightly different but tax loss harvesting is another tool an investor should have in their arsenal.

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8 thoughts on “ Tax loss harvesting as a retirement tool

    1. Hey Rick. As far as capital losses go, short term losses and long term losses are about the same. On Schedule D, short term gains and losses are tallied separately from long term gains and losses (since they are taxed at different rates). The capital loss carry forwards are also maintained separately. So, you can use the same strategy. This would apply I think if you happen to make a decent sized investment in a year that really heads south.


  1. I asked my accountant the same question and i am still unclear. Intra year, can short term gains and losses be off set? It looks like you can take 3k max of loss long per year, be taxed at your taxable income rate for short gains and 15% for long gains. You can carry long losses foward, 3k per year. Perhaps I understand all that.

    My concern is with the losses meaning… can I offset 5k of short gains with 5k of short loss? It appears like one can only take 3k of loss per tax year no matter where it comes from. Gains are taxed long (15%) for sales with capital gain and @ your tax rate if they are qualified dividends or from short sales gains.

    1. Rick, it is very confusing. Let me try again with an example. I highly recommend referencing the Schedule D form from the IRS.

      For a given year (intra year as you call it), say 2009, short term losses offset short term gains. So, if in 2009 you had $50K in short term gains and $50K in short term losses, you would have $0K in short term capital gains/losses for 2009. No taxable gains. These are lines 1 and 2 on Schedule D.

      Now, say in 2008 you had zero short term capital gains but had $30K in short term losses. On your 2008 tax form you would have -$50K in lines 1 and 2 on Schedule D, which you can only take -$3K maximum deduction for that year. So, the rest, $27K, carries over to 2009. Now in 2009, lets say you had $50K in short term gains and no losses. Lines 1 and 2 on sched D would then add up to $50K. Then on line 6 you would enter $-27K, your short term capital loss carry over. This results in a line 7 amount, net short term capital gain/loss, of $23K.

      So, all your short term losses will offset short term gains, its just a question of when. The tax code limits how much of a net loss you can report in one year but you don’t lose the remaining losses. They carry over forever until they are all used up.

      Hope that makes things a bit clearer.


  2. It helped Paul. I need to learn to use Cathy’s Turbo Tax and play with the Schedule D form.

    BTW the spread sheet outline has become one of our favorite “contemplation” tools.

    Thank you!

    1. That’s one of the best uses of the spreadsheet tool, lost of ‘what-ifs’ analysis to be done.


  3. Paul,

    Thanks for another insightful posting. One thing I want to make sure I understand. I was under the impression that any tax loss can be used dollar for dollar to offset capital gains. That is, a $10,000 tax loss can be carried forward and be used to offset a $10,000 loss the next year for example. My understanding is that the $3000 limit is only applied to earned income. That is, you can only use $3000 of the $10,000 to offset earned income such as a salary. (I am not clear how the offset could be applied to dividends however.)

    Is this correct?


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