Quick read
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By utilizing direct indexing, replacing the S&P 500 (SPY) with 150 to 250 stocks, you might incur losses between $30,000 and $50,000 annually while also saving $9,500 to $12,800 in taxes on a $1.2 million portfolio.
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It’s wise to capture tax revenue ahead of significant equity events and leverage Roth conversions to minimize IRMAA surcharges, all without invoking Medicare penalties from the lookback period.
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Interestingly, analysts in 2010 who recognized NVIDIA only highlighted their ten favorite stocks and didn’t include the SPDR S&P 500 ETF.
The 58-year-old engineer from Palo Alto, who files taxes jointly with his spouse, has an annual income of $750,000. He has invested $4 million into his 401(k) and IRA, along with another $1.2 million in a brokerage account that includes an S&P 500 fund, with the 401(k) being the largest investment. After maxing out the potential of the backdoor Roth, the next area for tax savings typically lies within taxable accounts for individuals at this income level.
This approach involves creating a direct index. Instead of just owning the SPDR S&P 500 ETF (NYSEARCA:SPY), this investor holds between 150 and 250 stocks in a separately managed account that closely tracks the index. The fund has no wrappers; each individual lot serves as a tax asset.
Why is the index rising while one-third of the names are being washed away?
Despite SPY rising nearly 9% this year, and 26% over the past year, that figure conceals significant underlying issues. For instance, Microsoft, which constitutes 5% of the index, has decreased by 16% since the year’s start. Similarly, JPMorgan Chase slid 6%, and Bank of America fell 9%, as the spread between the 10-year and two-year notes narrowed to roughly 0.5%, and the federal funds rate approached 4%.
Within SPY, these losses remain hidden. The fund melds net gains from winners like NVIDIA (+21%), Exxon Mobil (+27%), and Apple (+10%) into an aggregated figure. Meanwhile, directly indexed portfolios reflect all 500 stocks. You can sell the falling stocks while maintaining your index exposure.
The $40,000 figure was calculated from the bottom up.
In a typical year with normal volatility, around 30% to 50% of S&P 500 stocks may experience losses at some point, despite the index potentially finishing flat or better. A recent case was observed when the VIX surged close to 31 in March 2026, creating an opportunity to harvest losses across many interest-sensitive financial products and large-cap tech, although the index managed to bounce back.
A direct indexed sleeve worth $1.2 million could yield approximately $30,000 to $50,000 in losses yearly; let’s say around $40,000. When applied to capital gains at the 23.8% federal tax rate, including the NIIT, as well as $3,000 of retained earnings taxed at 32%, that amount would lead to tax savings of $9,520 to $12,800 in the same year. If these losses are taken more than 15 years prior to a step-up in basis upon death, savings can increase from $140,000 to $190,000.
This is where Medicare and Roth turn around.
By harvesting losses, you can reduce realized capital gains, lower modified adjusted gross income, and diminish IRMAA exposure for higher-income households. For those aged around 50 today, this approach creates a pathway for Roth conversions between the ages of 60 and 63 without hindering two years of Medicare retroactivity. The conversion results in ordinary income, but harvested losses won’t offset it directly. However, they can suppress capital gains and keep you out of higher surcharge brackets.
What should I actually do?
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Honestly assess your fee drag. Direct index SMAs from Fidelity, Schwab, and Wealthfront have investment ratios of around 0.25% to 0.40%, while SPY has an expense ratio of about 0.1%. For a $1.2 million investment, the added fees can range from $1,800 to $3,700. If the harvest results in tax savings exceeding $9,500, the numbers make sense. Generally, accounts under about $400,000 aren’t subjected to taxes.
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Check if you can transfer your current brokerage account in-kind. Some platforms allow high-value ETF lots to move into the SMA without triggering a sell-off, thus avoiding significant tax liabilities. Liquidating SPY with built-in profits can erase years of potential harvesting benefits in a single tax bill.
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Coordinate intensive inventory events and harvest schedules. Realized gains from RSU entitlements, ISO exercises, and planned sell-offs of private companies are most advantageous when paired with harvested losses in the same tax year. Also, keep an eye on wash sale periods around dividend ex-dates. For instance, MSFT will go ex-dividend on May 21, 2026, while XOM will do so on May 15, both within the 30-day exchange window of surrounding lots.
The 401(k) serves as the cornerstone. Taxable accounts provide wealthier households a hidden opportunity for an additional decade of after-tax compounding interest, and direct indexing is a strategy that many may not even consider.
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