How to Use Your Robo-Advisor to Save on Taxes

Learn how tax-loss harvesting can help you during tax season

Fact checked by Will Baker

Learn how to use your robo-advisor to save money on taxes with tax-loss harvesting (TLH) in your robo-advisor account. Tax-loss harvesting is a tax-planning strategy to minimize your tax bill. If you have taxable gains in your investment brokerage account as well as losses, you can sell the losing securities and use those losses to offset the taxable gains. 

The top robo-advisors automate the tax-loss harvesting process, which saves you time and money. The best low- or no-fee robo advisors expertly manage your investment portfolio while enabling you to keep more of your money instead of turning it over to Uncle Sam. We’ll explain the tax-loss harvesting rules and pitfalls to avoid and present the best robo-advisors with tax-loss harvesting. 

Key Takeaways

• Tax-loss harvesting: A legal tax strategy where investors sell a security for a loss to offset capital gains tax to increase after-tax income.
• Offsetting losses: Short-term losses must offset short-term gains, while long-term losses must offset long-term gains.    
• Wash-sale rule: Investors must comply with the wash-sale rule and avoid buying identical stocks or funds sold within a 30-day window.
• The complexities of tax-loss harvesting: Investors will find that tax-loss harvesting is difficult and time-consuming. Robo-advisors such as Betterment and Wealthfront conveniently offer this service at no additional cost.

Understanding Tax-Loss Harvesting

Tax-loss harvesting is an investment tactic to legally cut taxes to increase your after-tax income. In a taxable account, investors sell securities that are worth less than their purchase price. This creates a taxable loss, which can be used to offset taxable gains owed from selling profitable investments. Some robo-advisors harvest your tax losses for you, while others do not offer this service. 

How Does Tax-Loss Harvesting Work?

Sell an investment that is worth less than its purchase price. Calculate the total amount of the loss, and determine whether it is a short-term loss (for investments owned for less than one year), or a long-term loss. 

• Short-term losses must offset short-term gains initially.
• Long-term losses must offset long-term gains initially.

After all short-term gains are offset by short-term losses and long-term gains are offset by long-term losses, any additional losses may be used to offset ordinary income, up to $3,000 for single filers and married couples filing jointly or $1,500 for married individuals filing separately. Any losses that remain can be carried over and used in future years.

There is a caveat to tax-loss harvesting, called the wash-sale rule. The IRS mandates that for investors to benefit from the tax benefits of tax-loss harvesting, they must avoid buying the same stock, fund, or substantially identical security that was sold within a 30-day window. An example of a wash-sale violation is when a trader sells their Class A shares of Nike and then turns around to purchase Class B shares of Nike within a 30-day window. To avoid losing the tax-loss harvesting benefit and remain invested in similar securities, when replacing the sold asset, purchase one that is somewhat distinct. For example, if you sell Procter and Gamble at a loss, you might buy a consumer products sector fund to replace the P&G stock. You keep a comparable asset mix while avoiding running afoul of the wash-sale rule. 

How to Harvest Tax Losses With a Robo-Advisor

A robo-advisor manages your investments for low or no fees and can automate tax-loss harvesting to ensure your portfolio is optimized for the best returns. Invest with a robo-advisor that offers tax-loss harvesting in a taxable, non-retirement account, and with the click of a button, the digital investment manager takes care of the details. 

Although you can manage your own investments and sell losing positions to offset capital gains, it is time-consuming and requires a degree of investing and tax expertise. 

Below are the steps to follow: 

1. Understand your need for tax-loss harvesting: If you have a taxable investment account with a robo-advisor, then you will owe taxes on any net capital gain from the sale of a fund or individual asset. To minimize or eliminate the tax burden, you can select a robo-advisor that offers tax-loss harvesting to offset the gains by selling losing positions. Tax-loss harvesting benefits most investors with a taxable investment account.
2. Choose a robo-advisor: Not all robo-advisors offer tax-loss harvesting, and some, such as Schwab Intelligent Portfolios, require a minimum investment amount to be eligible for TLH. At Schwab Intelligent Portfolios, the account must be worth at least $50,000 to activate tax-loss harvesting. If you’re seeking robo-advisory management for a non-retirement (taxable) account, determine whether the provider offers tax-loss harvesting. Robo-advisors such as Betterment offer affordable services with tax-loss harvesting features that investors should consider for their portfolios.  
3. Open the correct robo-advisor account: Individual or joint taxable investment brokerage accounts are frequently available at robo-advisors and can benefit from tax-loss harvesting. Most trust accounts also benefit from tax-loss harvesting. There is no advantage to tax-loss harvesting in a traditional or Roth IRA, as gains and losses in retirement accounts are not taxable. 
4. Activate the tax-loss harvest feature: Tax-loss harvesting will either be automatic or manually activated. If tax-loss harvesting is automatic, then all taxable robo-advisor accounts receive TLH. For the optional TLH, there will be a button to indicate that you prefer tax-loss harvesting. Check the FAQ to find out how to implement the service. 
5. Monitor your portfolio: Whether you invest on your own or with a robo-advisor, it is wise to review your portfolio several times per year. Make sure that your asset allocation, or mix of stocks and bonds, is in line with your initial preferences. Validate that any transfers have occurred. Ensure that your balance and returns are in line with the movements of the portfolio benchmarks. For example, your S&P 500 ETF should have similar returns to the S&P 500 benchmark.

Robo-Advisors That Offer Tax-Loss Harvesting

Considering the complex nature of tax-loss harvesting, most investors will benefit from a robo-advisor that can help optimize the tax efficiency of their investments. The best robo-advisors will provide tax-loss harvesting at no additional charge; below are a few robo-advisors for investors to consider.  

Wealthfront

Tax-loss harvesting is automatic with Wealthfront, one of the oldest robo-advisors. When you open a taxable investment account with Wealthfront, you’re automatically enrolled in the tax-loss harvesting program. Wealthfront shares the results of its TLH and claims that on most accounts, the benefits from tax-loss harvesting more than offset the low 0.25% investment management fee. 

Betterment

Tax-loss harvesting is also automatic at Betterment, another legacy robo-advisor. All proceeds from TLH are reinvested into the investment portfolio to compound investment returns and growth. With no minimum investment required, and $10 to begin investing, new investors can benefit from professional investment management and higher after-tax returns. 

Schwab Intelligent Portfolios

Schwab requires a $5,000 minimum to invest in the fee-free digital portfolio and $25,000 for the Premium service (with unlimited financial advisor access). Investors with accounts valued at more than $50,000 of investable assets can activate the tax-loss harvesting feature.

Wells Fargo Intuitive Investor

Account holders can activate tax-loss harvesting for all Intuitive Investor taxable accounts. In “manage settings” and from the “I would like to” drop-down menu, the feature can be turned on or off at will. 

Vanguard Digital Advisor

Tax-loss harvesting is available at both Vanguard Digital Advisor and Vanguard Personal Advisor (with financial advisor access). To activate TLH at each program, you’ll need to request activation. With the Personal Advisor option, you’ll first discuss the option with your financial advisor. Once approved for tax-loss harvesting, investors will need to sign documents to authorize Vanguard to start harvesting for taxes. 

Pros & Cons of Tax-Loss Harvesting 

Tax-loss harvesting has a number of advantages and disadvantages that investors need to understand. Learn how these could influence your decision to choose a robo-advisor with tax-loss harvesting for your taxable investment account.

Pros

• Tax-loss harvesting offers the potential for investors to reduce their tax obligation on the capital gains they have acquired within their investments.
• Reinvesting the profits from tax-loss harvesting can result in higher compounded long-term investment returns. 
• Tax-loss harvesting enables investors to profit from market volatility by selling losing positions when markets fall and reinvesting the profits in similar assets at lower prices, yielding higher long-term returns. 

Cons

• High payments to an investment manager can offset gains from tax-loss harvesting. 
• Tax-loss harvesting benefits depend upon current tax rates in contrast with future tax rates, which are unknown. 
• For individuals, maintaining your own tax-loss harvesting requires a degree of investment management expertise and oversight.

Is Tax-Loss Harvesting Worth It?

In most cases, the benefits from tax-loss harvesting investments in a taxable investment account are worth it. You’ll typically find a boost in your overall returns if the proceeds are reinvested into the investment markets to compound and grow. Beginner self-directed investors might find the tax-loss harvesting procedure cumbersome and difficult to implement. 

When Is the Best Time for Tax-Loss Harvesting?

The best time for tax-loss harvesting is typically in the fall or end of the year. At that point, you can assess both short- and long-term gains from funds and individual assets that you expect to sell. With this knowledge, you can select funds and individual assets with losses to sell to offset the gains.

However, investors can seek out tax-loss harvesting opportunities throughout the year. Just remember not to let taxes drive investment decisions. Consider your overall strategy before selling solely to gain tax-saving benefits.  

What Is Tax Minimization?

Tax minimization strategies attempt to lower taxes in a variety of ways. The women-focused robo-advisor Ellevest employs tax minimization when rebalancing taxable portfolios. Ellevest maximizes taxable losses by selling assets with the largest losses and minimizes taxable gains to improve after-tax returns. 

Other tax minimization strategies include investing the maximum amount in an employer-sponsored retirement account, thereby decreasing taxable income. Asset location also curtails taxes by placing investments such as bonds and bond funds with higher tax liabilities in tax-favored retirement accounts such as traditional and Roth IRAs. 

Can Tax-Loss Harvesting Offset Ordinary Income?

Yes, tax-loss harvesting can offset ordinary income after losses have first offset short- and long-term taxable gains. In one year, the tax-loss harvesting limit for offsetting ordinary income is $3,000, after which all additional losses can be rolled over to claim in future years. 

The Bottom Line

Research has demonstrated that consistent tax-loss harvesting, if performed well, can increase long-term investment returns. Since the process requires a degree of expertise and time, leaving the tax-loss harvesting to a robo-advisor might be a sound reason to invest with a low-fee robo-advisor such as Wealthfront or Betterment. Wealthfront claims that tax-loss harvesting more than offsets the low investment management fee. 

While tax-loss harvesting with a robo-advisor in a brokerage or non-retirement account is typically a wise move, self-directed investors might have more difficulty with the process. Individual investors need to regularly monitor their investments to uncover harvestable tax losses. Next, finding suitable replacements for the sold assets and avoiding the wash-sale rule requires expertise. Finally, the risk of selling an asset after a short-term decline, only to watch the value soar going forward, might negate the short-term benefit from the tax-loss harvesting. Consult your accountant before embarking on a tax-loss harvesting program. 

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