Seed Your Future by Lowering Your Tax Bill
Automated daily tax-loss harvesting is available, at no additional cost, to all clients with a taxable, non-retirement account.
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- Wealthfront Account with Daily Tax-Loss Harvesting
- Wealthfront Account
- Amount Invested
Graph illustrates the potential benefits of Wealthfront’s Tax-Loss Harvesting strategy with an initial investment of $100k using hypothetical investment returns and medium risk portfolio. Disclosure
We simulated the potential differential investment rates of return of our daily tax-loss harvesting service using backtested historical results and found that it added an average of at least 1.55% for an Wealthfront 1000 account annually. We used several assumptions, (described here) including the asset class allocation of a client with a risk score of 7, a combined federal and state short-term capital gain tax rate of 42.7%, and a combined federal and state long-term capital gain tax rate of 24.7%, to create one possible approximation, but did not rely on actual client trading history, and our results should not be relied upon for predicting future performance. The results are hypothetical only. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. Wealthfront assumed we would have been able to purchase the securities recommended by the model and the markets were sufficiently liquid to permit all trading. These results are based on a study Wealthfront conducted for the years between January 2000 and August 2014 (described here), assuming a Wealthfront account with an initial deposit of $100,000, additional quarterly deposits of $10,000, and periodic rebalancing. Dividends and interest were not considered and results are presented net of fees.
A different methodology may have resulted in different outcomes. For example, we assume that an investor’s risk profile and target allocation would not have changed during the time periods shown; however, actual investors may have experienced changes to their allocation plan in response to changing suitability profiles and investment objectives. Furthermore, material economic and market factors that might have occurred during the time periods could have had an impact on decision-making. Actual investors on Wealthfront may experience different results from the results shown. There is a potential for loss as well as gain that is not reflected in the hypothetical information portrayed.
This is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.
When Wealthfront replaces investments with “similar” investments as part of the tax-loss harvesting strategy, it is a reference to investments that are expected, but are not guaranteed, to perform similarly and that might lower an investor’s tax bill while maintaining a similar expected risk and return on the investor’s portfolio. Wealthfront assumes no responsibility to any investor for the tax consequences of any transaction.
Tax loss harvesting may generate a higher number of trades due to attempts to capture losses. There is a chance that Wealthfront trading attributed to TLH may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, TLH strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income.
Wealthfront’s investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors.
The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against income and distributions. Losses harvested through the strategy that are not utilized in the tax period when recognized (e.g., because of insufficient capital gains and/or significant capital loss carryforwards), generally may be carried forward to offset future capital gains, if any.
Wealthfront only monitors for tax-loss harvesting for accounts within Wealthfront. The client is responsible for monitoring their and their spouse's accounts outside of Wealthfront to ensure that transactions in the same security or a substantially similar security do not create a “wash sale.” A wash sale is the sale at a loss and purchase of the same security or substantially similar security within 30 days of each other. If a wash sale transaction occurs, the IRS may disallow or defer the loss for current tax reporting purposes. More specifically, the wash sale period for any sale at a loss consists of 61 calendar days: the day of the sale, the 30 days before the sale, and the 30 days after the sale. The wash sale rule postpones losses on a sale, if replacement shares are bought around the same time.
The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term). Except as set forth below, Wealthfront will monitor only a client’s (or client’s spouse’s) Wealthfront accounts to determine if there are unrealized losses for purposes of determining whether to harvest such losses. Transactions outside of Wealthfront accounts may affect whether a loss is successfully harvested and, if so, whether that loss is usable by the client in the most efficient manner.
A client may also request that Wealthfront monitor the client’s spouse’s accounts or their IRA accounts at Wealthfront to avoid the wash sale disallowance rule. A client may request spousal monitoring online or by calling Wealthfront at 650-249-4258. If Wealthfront is monitoring multiple accounts to avoid the wash sale disallowance rule, the first taxable account to trade a security will block the other account(s) from trading in that same security for 30 days.
What is Tax-Loss Harvesting?
Tax-loss harvesting is a technique used to lower your taxes while maintaining the expected risk and return profile of your portfolio. It harvests previously unrecognized investment losses to offset taxes due on your other gains and income. You can reinvest these tax savings to grow the value of your portfolio.
Wealthfront developed software to make this service, traditionally only available to accounts in excess of $5 million, available to all taxable accounts. Between 2000 and 2013, our research shows tax-loss harvesting would have increased your after-tax returns by more than 1.55% a year. Over the next 20 years that could add more than $76k to a $100k portfolio. (See disclosures)
Is this legal?
Yes. The IRS allows tax‐loss harvesting, or “tax selling,” and financial advisors to the rich have done it manually for decades. For more about IRS allowances for capital gains and capital losses, please see the IRS website or consult your personal tax advisor.
Doesn’t tax-loss harvesting just defer tax liability?
Yes. Because the tax savings generated from tax-loss harvesting can be reinvested and compounded over time, you are almost always better off paying taxes later rather than sooner. Even if you can’t use the losses harvested in the near term, you can carry forward your losses and use them in later years.
Seems too good to be true…what’s the catch?
No catch. In addition to diversification and rebalancing, Wealthfront clients who invest in a taxable, non-retirement account get access to tax-loss harvesting. When you activate tax-loss harvesting, Wealthfront will continuously monitor your eligible accounts to harvest losses when appropriate.
Come tax time, Wealthfront will provide you with a Form 1099. You can write off any harvested losses against your capital gains and up to $3k a year against your ordinary income. You can even carry forward any remaining losses from one year to the next.