| By Laurence Greenberg
FINANCIAL PLANNING
A Better Way to Invest
Use flat-insurance fee VAs to maximize tax-efficient investing
and increase returns.
It is widely accepted that tax deferral is critical to maximizing retirement savings. In addition, many advisors use tax deferral to help improve
the performance of “tax-inefficient”
investments. An asset-location strategy,
under which assets are allocated among
taxable and tax-deferred accounts
based on tax efficiency, can increase
the after-tax returns of a portfolio by
more than 100 bps on tax-inefficient
asset classes, such as fixed income,
commodities and real estate, without
increasing risk.
One key to making this work is to
use a low-cost, no-load, tax-deferred
account like a flat-insurance fee variable annuity (VA). In a volatile market
in which every percentage point counts,
this may be just what your client needs
to save on taxes and potentially boost
his returns.
also includes actively managed investments that can suffer the biggest hit—short-term capital gains
tax, plus the added cost of multiple
transaction fees.
Location, location, location
Continue to place the most tax-efficient investments in a taxable
brokerage account. Shelter tax-heavy
investments by placing them in a
tax-deferred account. By deferring the
gains on the least tax-efficient investments, your clients can save more
after-tax money—the kind of money
they can actually spend or reinvest.
According to After-Tax Asset Allocation, a 2006 study by William
Reichenstein, finance professor at
Baylor University, REITs, bonds and
actively managed
stock funds consis-
tently perform better in
tax-deferred accounts,
such as 401(k) plans,
IRAs or low-cost VAs than
in taxable accounts. So,
once your clients maximize
their 401(k) and IRA contribu-
tions, a no-load, flat-insurance fee VA
may be the ideal choice to help them
improve tax efficiency, especially for
affluent clients whose qualified options
can quickly max out.
To effectively implement an asset-location strategy, consider how long
your client will hold the portfolio,
what asset classes he will hold and the
relative break-even periods for these
asset classes. General guidelines are
illustrated in the table below.
Table 1: Optimal Asset Location: Break-Even Guidelines*
Review your client’s portfolio
You can start by taking a fresh look at the
allocation of your client’s portfolio—not
just by asset class or risk—but by tax
efficiency as well. Arrange his investments
along a tax-efficiency spectrum, from the
most to the least tax efficient. On one end
of the spectrum, you will find tax-efficient
investments that generate long-term
capital gains and dividends, both of which
are currently taxed at rates of 15 percent
or less. These investments include S&P
index funds, funds with low turnover, and
investments you do not actively manage.
On the other end of the spectrum
are tax-inefficient investments that
generate ordinary income or short-term capital gains, currently taxed
at rates as high as 35 percent. These
include bond funds, REITs and many
hedge-like funds. Likewise, certain
commodities like gold can be taxed
as high as 28 percent. This category
Int’l Equity
US
Balanced
Money Market
Real Estate
Commodity
Bond
0 5 10 15 20 25 30
Years
Taxable
Tax-Deferred
(* Break-evens are based on the period from the fund’s inception through 12/31/2007. Based on return data
from the CRSP Mutual Fund database, calculated for the highest federal tax bracket. Average state taxes are also
included. The fund represented is a retail fund and the actual fees and performance of the equivalent VIT fund
may differ from the retail fund presented. VIT equivalents may not be available for all funds presented.)
