What is Tax Loss Harvesting Anyway?

Tax loss harvesting is the practice of selling a security that has experienced a loss—and then buying a similar one to replace it. The replacement does two things: it allows the investor to “harvest”, or realize, a capital loss on his or her tax return and, also maintain the desired robo-advisor investing - betterment achieves effect tax loss harvestingexposure to the asset class. The only way to realize a loss is to sell the depreciated asset. It is a relatively simple concept that is hard to do right when you have many asset classes and even more tax lots in your portfolio. Betterment’s TLH+ uses sophisticated software engineering to handle this complexity, scanning portfolios daily for losses (temporary dips that result from volatility), that can be harvested. Traditionally, a service like this was only available to high net worth investors—but Betterment now makes it more widely available than it ever has been before. Sophisticated DIY investors are also familiar with this practice, typically harvesting once a year, but daily harvesting, which is more effective, is virtually impossible to implement manually.

Betterment TLH+ Strategy: 

Betterment has built the best-in-class system from the ground up with the expertise of tax experts, software engineers, and investment specialists. At the heart of TLH+ is a powerful algorithmic system for robust tax lot and wash sale management via the proprietary innovative Parallel Position Management (PPM) system. This PPM system allows a single asset class to be comprised of two closely correlated securities indefinitely. This dual-ticker system eliminates the limitations of existing tax loss harvesting strategies–including inadvertently triggering short-term capital gains (and potentially leaving you owing more tax), cash drag, interference between your taxable and IRA accounts, and throwing off your asset allocation.

Betterment TLH+ Benefits: 

You will never be exposed to short-term capital gains as a result of an attempt to harvest losses. Through the proprietary Parallel Position Management system, a dual-security asset class approach which enforces preference for one security, never triggers a short-term capital gain in an attempt to harvest losses. You have zero cash drag at all times. With fractional shares, and robo-advisor investing - betterment harvesting rebalances across asset classesseamless handling of all inflows during wash sale windows, every dollar is always invested at the desired allocation risk level. Your harvests also serve as an opportunity to rebalance across all asset classes, rather than re-invest solely within the same asset class. This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and better after-tax returns. You will never experience a disallowed loss through overlap with your IRA. Betterment uses a tertiary ticker system, eliminating the possibility of permanently disallowed losses due to subsequent IRA activity. This makes Betterments TLH+ ideal for those who invest in both taxable and tax-advantaged accounts.

Should you use it?: 

Tax loss harvesting is beneficial for the majority of investors—when you can write off losses against capital gains, and/or up to $3,000 of ordinary income. Any losses not used to offset gains or ordinary income can be carriedadvisor investing - betterment harvesting lowers cost basis forward indefinitely until used up. The earlier you start tax loss harvesting—and the higher your current tax bracket—the more beneficial it can be over time.

However, harvesting lowers your cost basis, which can mean more taxes in the future—unless you don’t plan to liquidate your investments. That makes harvesting an especially beneficial strategy if you plan to donate some, or all of your assets to charity, or pass them down to your heirs, who will get a stepped-up basis. However, there are some specific instances when you should not use TLH+, or should proceed with caution. 

Harvesting losses is not appropriate if you are in a low enough tax bracket to realize capital gains tax free. More generally, TLH+ primarily adds value through tax deferral, which is undesirable if your future tax bracket will be higher than your current. If you expect to achieve (or return to) substantially higher income in the future, tax loss harvesting may be exactly the wrong strategy—it may, in fact, make sense to harvest gains, not losses. 

Also, married couples who both hold accounts at Betterment are ineligible to use TLH+, as trading in identical securities across spousal accounts would likely cause wash sales.


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