You should carefully read this disclosure and consider your personal circumstances before deciding whether to utilize i-wize’s Tax-Coordinated Portfolio (“TCP”) feature. For details on the operation of TCP and how it might impact particular investors, you should also read our TCP white paper and FAQs.
You are solely responsible for determining whether to use TCP and whether you would benefit from doing so. You retain that responsibility notwithstanding any general guidance that i-wize may give you regarding TCP. The value provided by TCP will vary depending on each investor’s personal circumstances. Investors who have a short time horizon, rely on tax-deferred (rather than tax-exempt) accounts, and expect to be in a high income tax bracket in retirement may get little to no value from the asset location strategy employed by TCP. Under certain circumstances, investors could conceivably even decrease their after-tax returns by enabling TCP.
As a general matter, asset location strategies like the one implemented by TCP distribute assets unevenly across multiple accounts based on the varying return profiles of each asset (separately considering the potential for capital appreciation and dividend yield). These figures are “expected returns”—projections for what future returns might be. While these figures are empirically derived (using Black-Litterman methodology) they are still speculative, and actual returns will differ year-to-year, often substantially.
Therefore, while the reasonable expectation may be that asset A will pay more dividends than asset B (and/or appreciate more than asset B), the opposite could happen in any given year, or across a number of years, such that asset location decisions based on differing expectations do not maximize after-tax returns. The longer the investing period, the more likely it is that the relative performance of the various assets in the portfolio will converge on what is expected. Shorter periods, however, are more likely to produce unexpected results.
Asset location seeks to place assets with higher expected returns into tax-advantaged accounts. Therefore, towards the end of the accumulation phase, an investor should expect his or her tax-advantaged accounts to have a higher balance than they otherwise would have been (and the taxable retirement account to have a lower balance than it would have been, had an asset location strategy not been deployed).
While under most circumstances, more growth in a tax-advantaged account (in exchange for less growth in a taxable account) is desirable, there are potential trade-offs which should be considered. For instance, tax-advantaged accounts incur penalties for early withdrawal, so to the extent that access to funds prior to retirement becomes necessary, liquidity may come at a higher cost for a portion of funds that might otherwise be accessible penalty-free (had that appreciation taken place in the taxable account instead).
If the tax-advantaged assets are primarily or exclusively tax-deferred, rather than tax-exempt (e.g. a traditional IRA vs. a Roth IRA) then additional considerations should be weighed. Because all distributions from a tax-deferred account are taxed at ordinary rates, including amounts that would be taxed as long-term capital gains when realized in a taxable account, shifting such appreciation could amount to a conversion of lower taxed income into higher taxed income.
Over a long enough period, the tax deferral (i.e. the ability to continually reinvest the tax savings and compound that growth, before eventually paying the tax) is expected to be valuable enough to justify such a conversion. This is especially likely when the taxpayer expects to be in a lower income tax bracket in retirement than during the accumulation phase (often, though not always the case). However, when asset location is practiced over a short period (years, not decades) and the taxpayer maintains a high income tax bracket at the time of distribution, conversion of some capital gains into ordinary income may dominate the after-tax return, thereby rendering the asset location strategy counterproductive.
As a separate matter, a higher tax-deferred balance could mean higher required minimum distributions (“RMDs”) in retirement, which could be an important consideration for those seeking to minimize their RMDs.
Generally, TCP may not be right for you if: (1) you are currently in a low tax bracket, and expect to be in a low tax bracket when you withdraw from the coordinated portfolio (typically during retirement), (2) one of the accounts that you would include has a significantly different time horizon than the other accounts, (3) if you are engaged in complicated estate planning due to an impending or recent death, or (4) If you might recharacterize or convert a retirement account in the future.
i-wize does represent in any manner that TCP will result in any particular tax consequence or that specific benefits will be obtained for any individual investor. The TCP service is not intended as tax advice. Please consult your personal tax advisor with any questions as to whether TCP is a suitable strategy for you in light of your individual tax circumstances.