I guess I always knew it, but I sure wasn’t thinking about the real effects of market losses before reading a trade publication article by Allan Roth.
For example, suppose your statement showed you have $100,000 in an IRA at the beginning of the year and you’re in the 25% tax bracket. What the statement isn’t telling you is that $25,000 of that money doesn’t belong to you. Your real balance is $75,000.
Now suppose your account took a 20% market loss in value. Your balance is now $80,000, but did YOU lose $20,000? Nope. Your balance, because of your 25% tax bracket, is now $60,000, because the I.R.S. owns it’s 25%, or $20,000.
So, while your statement shows a drop of $20,000 from $100,000 to $80,000, the fact is your loss was $15,000 – a drop from $75,000 to $60,000. The other $5,000 is the government’s loss.
But, of course, it’s all on paper. Losses don’t really get realized until they’re, well, realized… only when you sell. And, historically, markets have always seemed to come back to reach new highs. We don’t know when it will happen again; but, I wouldn’t bet against it.