Inheriting an investment account can significantly impact your financial situation, but it also comes with important tax considerations. Whether you’ve inherited a regular brokerage account, an IRA/401(k), Roth IRA, or a trust, understanding the tax implications is crucial for managing your newfound wealth effectively. This article will guide you through the key tax issues related to these types of accounts, including stepped-up basis, required minimum distributions (RMDs), and other factors that could affect your financial planning.
When you inherit a regular brokerage account, such as one holding stocks, bonds, ETFs, or mutual funds, one of the most significant tax advantages is the "stepped-up basis." The stepped-up basis allows you to reset the cost basis of the inherited assets to their fair market value at the date of the decedent’s death. This can substantially reduce the capital gains tax you would owe if you decide to sell the assets.
Example: If your benefactor bought a stock for $10 per share and it’s worth $50 per share at their death, your cost basis is "stepped up" to $50. If you sell the stock at $55, you’ll only owe capital gains tax on the $5 increase, rather than the $45 increase from the original purchase price.
However, this benefit applies only to assets in taxable accounts. If the value of the assets increases after the date of death, those gains will be taxable when you sell the assets. Additionally, any dividends or interest earned after the decedent's death will be taxable as income to you.
If inherited assets are transferred to your name from another financial institution, it's essential to make sure that the cost basis is updated. Correcting this ensures you don't pay unnecessary capital gains taxes when selling the assets, preserving more of your inheritance.
Inheriting a traditional IRA or 401(k) involves a different set of rules, primarily because these accounts typically consist of pre-tax contributions. This means that any distributions you take will be subject to ordinary income tax.
RMDs: If you inherit an IRA or 401(k) from someone who was already taking required minimum distributions (RMDs), you must continue taking RMDs based on your life expectancy or follow the 10-year rule, which requires you to deplete the account within 10 years of the original account holder's death. If the account owner had not yet reached the age for RMDs, you generally have more flexibility but still need to comply with distribution rules within the 10-year timeframe.
Roth IRAs: Inheriting a Roth IRA is more advantageous from a tax perspective. Since contributions to Roth IRAs are made with after-tax dollars, distributions are generally tax-free as long as the account has been open for at least five years. You still need to follow the 10-year rule for depleting the account, but you won’t face the same tax burden as with a traditional IRA.
Spousal Inheritance: If you inherit an IRA or 401(k) from a spouse, you have additional options. You can treat the account as your own, either by rolling it into your own IRA or by remaining the beneficiary and taking distributions according to your life expectancy. This allows for greater flexibility and can provide more control over the tax impact.
Trusts are often used to manage and distribute assets according to the grantor’s wishes, offering both tax advantages and protections for beneficiaries. When you inherit a trust, the tax implications will depend on the type of trust:
Revocable Trusts: Also known as living trusts, these are still considered part of the grantor’s estate and are subject to estate taxes. Upon the grantor’s death, the trust assets receive a stepped-up basis similar to regular brokerage accounts. Distributions to beneficiaries are typically not taxed directly, but are instead tied to the trust’s income and capital gains.
Irrevocable Trusts: With an irrevocable trust, the assets are removed from the grantor’s estate, which can help reduce estate taxes. However, the tax treatment of distributions depends on whether the trust retains the income or distributes it to beneficiaries. Beneficiaries who receive distributions will generally pay income tax on the income generated by the trust, rather than on the distributions themselves.
Special Considerations: Trusts can also be subject to high tax rates on undistributed income, so it’s often advantageous to distribute income to beneficiaries, who may be in lower tax brackets. Additionally, trusts can have complex rules regarding how assets are managed and distributed, so it’s essential to work closely with your financial advisor and your attorney to understand the implications fully.
Inheriting investment accounts can significantly affect your financial future, but it’s essential to navigate the tax implications carefully. Understanding the differences between regular brokerage accounts, IRAs/401(k)s, and trusts, and how each is taxed, can help you make informed decisions that align with your financial goals. Working with a financial advisor who has an expertise in tax can provide invaluable guidance, ensuring that you maximize the benefits of your inheritance.
Thank you for reading,
The Canty Financial Team
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
We frequently hear from clients who have a few scattered investment accounts or old employer retirement plans that they’ve left behind. These accounts often end up spread across different institutions, causing stress and concern about potentially forgetting about them and leaving money unclaimed. Managing multiple accounts can become overwhelming and stressful, but consolidating your investment accounts can provide significant benefits, helping you optimize your financial strategy and gain peace of mind. Here’s why you should consider consolidating your investment accounts.
One of the most significant advantages of consolidating your investment accounts is the simplification it brings to your financial life. With all your investments in one place, it becomes much easier to track performance, monitor asset allocation, and make informed decisions. You no longer have to log into multiple accounts to get a comprehensive view of your financial health. Instead, a consolidated account provides a holistic picture, allowing for more straightforward management and oversight.
Maintaining multiple accounts often means incurring multiple sets of fees. These can include account maintenance fees, trading fees, and advisory fees. By consolidating your accounts, you can reduce or eliminate many of these redundant fees. Additionally, many financial institutions offer lower fees or additional services for larger account balances, so combining your investments can make you eligible for higher-quality service levels.
Consolidating investment accounts allows for a more cohesive and optimized investment strategy. When your assets are spread across different accounts, it can be challenging to ensure that your overall portfolio is properly diversified and aligned with your risk tolerance and financial goals. Consolidation helps you create a unified investment plan that takes into account all your assets, ensuring a balanced and well-coordinated approach.
Regularly rebalancing your portfolio is essential to maintaining your desired asset allocation and risk level. However, rebalancing can be complicated when dealing with multiple accounts at different institutions. Consolidating your investments makes it much easier to perform this crucial task. With all your assets in one place, you can efficiently rebalance your portfolio, ensuring that it remains aligned with your long-term objectives.
Tax season can be stressful, especially if you have to deal with multiple account statements and tax documents. Consolidating your accounts simplifies tax reporting by reducing the number of forms you need to manage. A single consolidated account provides a unified statement, making it easier to track your taxable events, such as capital gains and dividends, and ensuring accurate and efficient tax filing.
Working with a financial advisor becomes more effective when all your investments are consolidated. Advisors can provide better, more comprehensive advice when they have a complete view of your financial situation. Consolidation allows your advisor to develop a more personalized and strategic financial plan, tailored to your unique needs and goals. It also facilitates more effective communication and collaboration between you and your advisor.
Finally, consolidating your investment accounts can provide you with increased confidence and peace of mind. Knowing that all your investments are organized and managed under one roof reduces the stress and uncertainty associated with managing multiple accounts. It allows you to feel more in control of your financial future and ensures that you are not leaving any money behind or forgetting about any accounts.
Consolidating your investment accounts can seem like a daunting task, but it’s a straightforward process when broken down into manageable steps. Here's how you can roll over your old employer 401(k) and consolidate IRAs and brokerage accounts.
Consolidating your investment accounts offers numerous benefits, from simplified management and reduced fees to optimized investment strategies and easier tax reporting. It enhances your ability to maintain a well-balanced portfolio, work effectively with your financial advisor, and ultimately achieve your financial goals. If you have multiple investment accounts, now is the time to consider consolidation as a strategic move towards a more organized and efficient financial future.
At Canty Financial, we are here to help you navigate the consolidation process and create a streamlined, effective investment strategy tailored to your needs. Contact us today to learn more about how we can assist you in consolidating your investment accounts and optimizing your financial plan.
Thank you for reading,
The Canty Financial Team
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
Tax planning is a cornerstone of a solid retirement plan, ensuring you can enjoy retirement while maximizing the savings accumulated throughout your career. Understanding how different income sources are taxed, and leveraging strategies to minimize these taxes is critical. Additionally, the guidance of a trusted financial advisor who knows your situation, understands the complex tax landscape, and acts as a sounding board for your ideas and questions is indispensable.
Retirement income has unique tax implications, depending on the account type or investment:
The strategy you use to withdraw from your retirement savings plays a crucial role in managing your tax impact. Typically, prioritizing withdrawals from taxable investment accounts first, to take advantage of potentially lower capital gains rates, is advisable.
Then, accessing funds from tax-deferred accounts like 401(k)s and traditional IRAs can help, as these are taxed as ordinary income upon withdrawal.
Integrating Roth IRAs into your strategy adds valuable tax diversification and flexibility, given that qualified distributions are tax-free.
Understanding the nuances of Required Minimum Distributions (RMDs) and selecting the appropriate investments to liquidate are also essential for minimizing tax liabilities. At Canty Financial, we emphasize tax-efficient withdrawal planning as a vital part of our retirement planning services, aiming to enhance your financial outcome in retirement.
Considering tax implications prior to making investments can lead to substantial tax savings and provide increased after-tax returns. The choice between investing in traditional IRAs versus Roth IRAs, for example, should be influenced by your current and expected future tax situations.
Contributions to Health Savings Accounts (HSAs), if eligible, also offer tax benefits and can act as a substitute for your IRA or other tax-deferred accounts. Contributions to HSAs are tax deductible and if used for qualified medical expenses distributions are tax-free. Any distributions from HSAs after age 65 are considered ordinary income, but not subject to a 10% penalty.
Exchange traded funds are more tax efficient and have less capital gain distributions compared to similar mutual funds, allowing you to keep your money invested rather than having to pay large tax bills each year. We construct portfolios of ETFs at Canty Financial, giving our clients more tax-advantageous portfolio structures.
Tax-loss harvesting is a strategy to offset capital gains with losses reducing your net tax burden. At Canty Financial, we leverage our portfolio rebalancing software, 55IP, to automate this process. Tax loss harvesting opportunities are consistently analyzed every 30 days, allowing our clients to take advantage of fluctuations in the market. If a fund can be sold at a loss, we will realize the loss by selling that ETF and then purchasing a very similar fund. This allows our clients to take advantage of the loss while remaining fully invested at all times. This approach is particularly beneficial for managing large, unrealized gains and for transitioning accounts to a new portfolio with minimal tax impact.
Charitable giving, including Qualified Charitable Distributions (QCDs) from IRAs, can reduce taxable income and is highly effective if you are subject to RMDs or if you take the standard deduction. Donating appreciated assets directly to charity can also circumvent capital gains taxes, offering a tax-efficient way to support charitable causes.
We assist clients in developing estate planning strategies that minimize transfer taxes and facilitate the efficient transfer of wealth to heirs. This may involve the use of trusts, beneficiary designations, transfer on death titling, and strategic gifting. Understanding the rules and benefits of annual gifting can further reduce tax bills.
State taxes can also affect retirement income. For instance, New York State does not tax Social Security or public pensions and offers a $20,000 exclusion for retirement account withdrawals.
Certain income such as interest from U.S. government bonds are also tax-exempt in many States.
Planning for State taxes, especially if considering a move in retirement, is crucial for minimizing overall tax burdens.
Tailoring tax planning strategies to individual circumstances requires professional insight. The landscape of tax laws and personal situations is ever-changing, highlighting the need for ongoing tax planning.
At Canty Financial, we prioritize the integration of tax considerations into your comprehensive financial plan, covering areas such as retirement, estate planning, and investment management. Our approach ensures that our clients experience no gap between their tax strategy and their broader financial decisions, a common issue when advisors lack sufficient tax knowledge.
Engaging with a financial planner or tax professional goes beyond mere tax compliance, it's about maximizing your financial potential in retirement. By understanding and applying these strategies, retirees can significantly reduce their tax burdens, securing a more prosperous and worry-free retirement.
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
We are excited to begin 2024, marking the 37th year of our firm's history. As we continue our journey, here are some important updates and enhancements to our services that we're thrilled to share with you.
Read our latest market insights and our recent rebalance strategy in our CFM Investment Commentary. We invite your questions and look forward to discussing these topics with you.
We're excited to continue our collaboration with institutional portfolio managers such as J.P. Morgan, BlackRock, Clough Capital, and State Street. This partnership aims to optimize our model portfolios, leveraging their extensive market experience and advanced analytical tools. This strategy enhances our ability to offer you diversified, robust investment options tailored to meet your individual financial goals.
Stay up to date on the latest financial planning news by subscribing to our monthly newsletter here.
We encourage you to explore the new features of our software and connect with a CFM advisor for personalized and tailored guidance. We look forward to helping you navigate your financial journey into the new year.
Best regards, The Canty Financial Management Team
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
It’s important to understand the tax implications of investment decisions because taxes can have a significant impact on your investment returns. Here are some real-life examples we’ve seen of tax investment mistakes.
There are several common tax mistakes associated with IRAs and Roth IRAs, including:
Taking a large distribution out of a retirement account to buy a house can have several negative consequences, including:
Understanding your cost basis is essential before selling an investment. The cost basis is the original purchase price of an asset. When you sell an asset, you will owe taxes on any gain above the cost basis. If you sell an asset for less than the cost basis, you may be able to claim a loss for tax purposes.
If you sell an asset after holding it for less than a year, any gains will be considered short-term capital gains and will be taxed at your ordinary income tax rate. However, if you hold the asset for more than a year before selling it, any gains will be considered long-term capital gains, which are taxed at a lower rate.
For this reason, understanding your cost basis is crucial to accurately calculate your tax liability and avoid overpaying or underpaying taxes. If you do not know your cost basis, you may end up paying more in taxes than you owe or risk facing penalties for underreporting your income.
As an elderly person, it can be better to not realize gains on investments and instead hold onto them to get a stepped-up basis because it can potentially reduce the capital gains tax liability for you and your heirs.
When an individual dies, their heirs generally receive a "stepped-up basis" for inherited assets, including investments. This means that the basis of the asset is "stepped up" to the fair market value on the date of the individual's death, regardless of the original purchase price. For example, if an individual purchased a stock for $10 and it is worth $50 at the time of their death, their heirs would inherit the stock with a basis of $50.
If the heirs were to sell the inherited asset, they would only owe capital gains tax on any increase in value that occurs after the date of the individual's death. This can potentially reduce or even eliminate the capital gains tax liability. However, this strategy should be considered in the context of the individual's overall financial situation and goals, as there may be other factors that weigh against holding onto investments for an extended period.
Frequent large capital gains distributions out of mutual funds can erode investment returns over time. Mutual funds can issue capital gain distributions to the fund’s shareholders at any time. These distributions are taxable, even though the shareholder did not sell any portion of the mutual fund. Depending on the size of the distribution and the shareholder's tax bracket, the tax liability can be significant, reducing the overall investment return.
On the other hand, ETFs (Exchange Traded Funds), offer more control over taxable events. Most ETFs do not have capital gain distributions, so taxpayers are less likely to be hit with a large tax surprise at the end of the year. Shareholders of ETFs realize gains when they sell, so they have much more control over when they would like to realize a gain. At Canty Financial we build our portfolios primarily using ETFs with the goal to maximize our client’s after-tax returns.
Overall, it's important for investors to be aware of the potential impact of capital gains distributions on their investment returns over time. If investors are forced to sell investments to pay a large tax bill on a capital gain distribution each year, then it's highly likely to have a negative impact on long-term returns.
If you have any questions about the tax implications of your investments, please feel free to reach out, we are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Tax Advisor
Tina Alteri, CPA, Tax Advisor
Changing jobs is a time of transition with a lot to do. Getting up-to-speed at your new employer is important and a top priority. When leaving a company, it’s crucial not to forget about your old 401(k) account. What to do with this retirement money is a critical decision to make during this period of transition.
When leaving your employer you have several options regarding your 401(k) account balance.
Taking a distribution will generally result in the money being subject to taxes and potentially a 10% penalty for those who are under age 59 ½. Unless the money is needed immediately for some reason, we generally do not recommend this option.
Leaving the money in your old employer’s plan can be a good option in some cases. However, some plans treat former employees differently from active participants in terms of the investments available to them. They may even place their money in a separate account designated for former employees who have left their balances in the plan.
We generally advocate that clients who are leaving their job consider rolling their plan balance over to either an IRA or in some cases to their new employer’s plan if applicable.
To the extent possible, it makes sense for investors to have their investments in as few places and accounts as is feasible for their situation. For example, it's easy to forget about an old 401(k) account at a former employer, especially if the account balance is relatively small. All retirement savings are important and should be managed in line with your overall retirement planning and investment strategy.
Rolling your 401(k) account to an IRA at an outside custodian or to a plan at your new employer, if applicable, can help ensure that this money is properly managed and not forgotten. It's easier to focus on managing funds in a smaller number of locations than if the money is spread across a number of accounts held by various custodians.
Having investments spread around in a number of locations is also terribly inefficient and takes more work on your part in terms of reviewing your asset allocation and other aspects of your overall portfolio.
Rolling a 401(k) over to an IRA account at an outside custodian offers a number of advantages in terms of managing your portfolio. It is often the path we recommend to our clients who are leaving their job and moving on to another company, or into a self-employment situation.
First, the IRA will offer a much wider array of investment choices than leaving the money in an old employer’s 401(k) or rolling the money over to a new employer’s plan. This includes investments such as individual stocks, bonds, and ETFs plus a much broader array of mutual funds than what is typically available inside a 401(k) plan.
This wider range of investment choices allows us to integrate this additional retirement money into the overall investment strategy we employ for the client’s other assets directly under management by us. We always work with clients to integrate the choices within their employer’s 401(k) plan into their overall strategy. But having the money in an IRA allows us to utilize the same investment options we use elsewhere in the client’s portfolio.
The quality of the investment menus inside 401(k) plans varies widely. Some plans offer a solid array of investment options. Plans offered by larger employers may offer a better menu than plans from smaller employers. However, when our client’s money is rolled over to an IRA, we can often invest the money in lower-cost options than those that were available in their old 401(k).
IRAs can also offer a degree of planning flexibility that may not be available in a 401(k). If it makes sense to do so, money held in a traditional IRA account can be converted to a Roth IRA. Money that was held in a designated Roth account in an old 401(k) can be rolled over to a Roth IRA where it will not be subject to required minimum distributions when you reach that age.
In some cases, we find that it makes sense for a client to roll their 401(k) balance over to a new employer’s 401(k). The key factor is the quality of the investments offered in their new employer’s plan. If this is the case, then merging their old 401(k) account into this new plan can enable you to manage a large portion of your retirement in a consolidated fashion that is in line with your overall strategy.
For those who are working at age 73 and beyond, money held in their employer’s 401(k) is exempt from required minimum distributions as long as they are not a 5% or greater owner of the company and if their company makes this election as part of the plan documents.
Additionally, 401(k) plans offer higher levels of creditor protection than IRAs, which can be a factor for some investors.
When leaving an employer, your choices regarding your 401(k) are important. This retirement money needs to be managed in a fashion that is consistent with your overall investment strategy to help ensure that it keeps working to fund your retirement goals. Generally rolling this money to an IRA, or in some cases to a new employer’s 401(k), will be the best course of action.
Please give us a call to discuss your 401(k), IRA, or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Tax Advisor
Tina Alteri, CPA, Tax Advisor
ETFs and mutual funds are the two main types of managed accounts for investors. The IRS tax treatment of ETFs and mutual funds is the same, however, the structure of ETFs can make them a more tax-efficient option for taxable accounts.
Let’s take a look at why ETFs are generally more tax-efficient than mutual funds.
One of the biggest reasons for the generally greater tax efficiency of ETFs compared to their mutual fund counterparts are differences in structure. First, there is a higher percentage of actively managed mutual funds compared to the number of actively managed ETFs. The turnover in an actively managed fund is generally much higher during the year than with either an index mutual fund or ETF.
Even when compared to index mutual funds, ETFs still have the advantage when it comes to tax efficiency. Mutual funds, even passively managed index mutual funds, can be forced to generate capital gains inside of the fund when they need to raise cash to meet client redemption requests. When a mutual fund manager needs to raise cash, they need to sell stocks or bonds held inside the fund. This can lead to the generation of unplanned capital gain distributions, both long-term and short-term. These capital gains are passed through to all remaining shareholders of the mutual fund.
By contrast, only around 10% of the trades made by an ETF fund manager involve buying or selling the underlying securities held by the ETF. When ETF shareholders need to raise cash for whatever reason, they would simply sell some or all of their ETF shares during the trading day as they would with shares of an individual stock they might own. Any capital gains or losses realized by a shareholder of an ETF impact solely them and not the other ETF shareholders.
ETF managers manage investment inflows and outflows through the creation or redemption of creation units. These creation units allow the ETF manager to do in-kind redemptions and exchanges of individual securities for ETF shares, reducing the need to sell these individual securities for cash and generating capital gains inside of the ETF. This process can help eliminate or drastically reduce the generation of capital gains during the process of rebalancing the portfolio.
One aspect of mutual fund investing that can be very frustrating for investors are year-end distributions. In some years, mutual fund investors in taxable accounts may receive hefty capital gains distributions. This can be especially costly and frustrating if those capital gains are short-term gains that are taxed at their ordinary income tax rate. Often investors or their advisors must wait until the end of the year to find out what types of year-end, taxable distributions they are facing.
Like mutual funds, stocks, or other securities, ETF investors will incur capital gains taxes if they sell shares of an ETF and realize a gain on the sale. But in this case, the investor has control over when shares of an ETF are sold and the timing of any capital gains.
Dividends from both ETFs and Mutual funds may be taxed as qualified dividends if the investor has held the fund for at least 60 days. Qualified dividends are taxed at a rate ranging from 0% to 20%, depending upon the investor’s tax bracket. If the shares have been held for less than 60 days, then the dividends are taxed at the investor’s ordinary income tax rate.
Some international equity ETFs, both in developed and emerging markets, have the potential to be less tax efficient than domestic equity ETFs. Especially with emerging markets ETFs, there may be rules prohibiting in-kind exchanges. Some commodity and inverse ETFs also may not be as tax efficient as ETFs focusing on domestic equities and bonds.
In building our client model portfolios we use ETFs extensively in large part due to the tax efficiencies mentioned above. This is especially true for clients whose portfolios include taxable accounts. We feel that minimizing taxes is important not only for the current year's tax returns of our clients but minimizing taxes can help add to returns over a longer period of time.
Beyond taxes, ETFs offer several other advantages for our clients.
Our investment process is about balancing risk and reward for our clients as a key part of their overall financial planning strategy. The individual components of our investment models are each chosen based on our assessment of how they contribute to this overall goal. ETFs offer a number of advantages, even beyond their tax efficiency, which is why we use them in constructing client portfolios in both taxable accounts and in tax-advantaged accounts like IRAs.
To learn more about our investment strategies and how they can help you achieve your financial planning goals, please feel free to reach out.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor
Asset location pertains to the types of investment assets that are best held in various types of accounts. Asset location is a tax minimization strategy that matches various types of investments with the type of account best-suited for that type of investment holding.
Asset location is about strategically holding investments in accounts where you are likely to achieve the highest after-tax returns. This includes taxable investment accounts, tax-deferred accounts such as a traditional IRA or 401(k), or tax-free accounts which are usually Roth accounts.
Due to the nature of dividends, interest, or capital gains connected with certain types of investments, it might be most tax-efficient to hold them in one type of account versus another. This is the essence of asset location.
While it is not always possible to align your entire portfolio in a perfect fashion in terms of asset location for each holding, it does make sense to pay attention to this when deciding which investment holdings fit best into your various accounts.
The following types of holdings can be well-suited for a taxable account:
Note at this writing we don’t know what, if any, changes the current administration might propose to the tax rates for long-term capital gains. If capital gains rates are drastically increased as some have speculated, this might change some of our thoughts above.
Certain types of investments may be best suited for tax-deferred retirement accounts such as traditional IRA and 401(k) accounts or tax-free Roth accounts. Some examples include:
Asset location can be an important consideration in investing as we all want to invest in the most tax-efficient way possible.
In our opinion, however, asset allocation should govern your investing strategy. This includes the types of investment vehicles, the asset classes included in your portfolio, and the percentage amounts allocated to each of the various asset classes.
Sometimes your situation doesn’t allow you to perfectly align the asset location of every holding within your portfolio. This might be a function of the relative size of the balances in your various types of accounts or other factors.
Where appropriate and feasible, we feel that using asset location principles to determine which holdings are located in various types of accounts makes sense for most investors. However, we would caution investors to use good common sense in implementing an asset location strategy.
For example, incurring unnecessary taxable income to realign your portfolio generally defeats the whole purpose of asset location which is tax savings.
There are a number of ways to realign your portfolio to be more in line with an asset location strategy that best fits your situation. These include:
When considering an asset location strategy for your portfolio, it's important to keep both current and future tax implications in mind. For example, will you be in a higher or lower tax bracket in retirement?
Asset location should be implemented as part of your overall financial plan and your investing strategy. If done correctly, asset location can be a key tool in your tax planning efforts.
If you are looking for a fee-only fiduciary financial advisor who will always put your interests first, please give us a call to discuss asset location or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor
For many of us, our employer’s 401(k) plan is our primary retirement savings vehicle. Participating in the plan is generally easy and painless. Your contributions are deducted from your paycheck each pay period, there is nothing that you need to do other than select how you want your money invested. Some companies even offer a matching contribution on top of what you contribute.
Even with these attributes, you still want to be sure that your company’s 401(k) plan is a good one and that it is a good place for your retirement savings. It's important to evaluate the plan in several areas.
A key factor in evaluating your company’s 401(k) is the quality of the investment lineup offered. Quality encompasses several features.
Do the mutual funds or other investment offerings allow you to build a diversified portfolio? Are there funds offered across a range of asset classes and sub-asset classes for stocks, bonds, and a cash option? Does the plan offer several low-cost index funds, for example, an S&P 500 index or one that replicates the total U.S. stock market?
How do the funds compare to other funds in the same asset class? Where mutual funds or ETFs are used you can check on this using a service like Morningstar. The annual fee notice report that you receive from your employer will generally show a comparison of the investments to a benchmark like the S&P 500 or the Russell 2000, but usually not to other funds in the same asset class peer group.
Matching from your employer can help increase your plan balance. This is basically free money. The matching formula might be on the order of a 50% match on the first 6% of your salary deferral contributed to the plan. The higher the match obviously the better.
Another aspect of the employer match is the vesting formula, this refers to the time period in which the company match is yours should you leave the company. A typical formula is that you earn ownership in 20% of the match each year with full ownership occurring after five years with the company.
In addition to a matching contribution, some companies will make an annual profit-sharing contribution to your 401(k) account. These contributions are optional, the company can skip a year if they had a bad year financially or for any other reason.
All of these company contributions serve to enhance your retirement savings efforts beyond your own contributions. The amount that your company contributes to the plan on your behalf is a factor in evaluating the quality of your plan.
High expenses are a major impediment to retirement savers trying to build a retirement nest egg. Studies by the SEC and others have shown that even a relatively small difference in investment expenses can have a dramatic impact on the growth of your investments over time.
Plan expenses come in several forms. There are the expense ratios of the mutual funds or other investments offered. Expense ratios are deducted from the gross returns of the funds the same as with investments in mutual funds made outside of the 401(k).
Some plans may also charge some or all of the administrative costs of running the plan to the accounts of the participants. This is generally done on a pro-rated basis determined by the relative size of your balance as a percentage of the total assets in the plan, but there may be a different formula used in some cases.
Plan expenses are disclosed in the annual fee notice that your employer is required to send to you. You may have to dig through it a bit to determine what expenses beyond the mutual fund expense ratios are being charged to your account. What you will need to do is to look up the fund’s expense ratio in the prospectus that you were given, or in the case of mutual funds, you can do so on a site like Morningstar. If there is a difference between the expense ratio of the fund and the amount listed on the annual fee report, this will represent the plan administrative fees being charged to your account.
If you’ve done your homework and you decide that your company’s plan is not as good as it could be, you have some options. One is to not contribute to your plan or to only contribute enough to receive the full match offered by your company if they do matching contributions. This isn’t the most preferable option as you are missing out on the ability to contribute to a tax-advantaged retirement account.
If you are married and your spouse has access to a good plan through their employer, be sure to max out contributions to that plan.
If you feel your employer’s plan could be improved in terms of the plan’s expenses or the quality of the investment menu, it can pay to voice your concerns to the plan’s administrator or to senior management. Of course, you want to be respectful in voicing your concerns, and you will need to be able to articulate the issues you see. Perhaps it is with the quality of the investments or the costs of the plan. With the rash of participant lawsuits against 401(k) sponsors in recent years, many employers are more receptive to this type of feedback. For many companies having a good 401(k) plan is a vehicle to attract and retain top employees in a competitive job market.
We periodically review our client’s 401(k) plans as part of the financial planning and investment services we provide. The assets in their 401(k) accounts are a key piece of their overall investment portfolio. In the process of determining how they should invest their 401(k) assets, we review the overall quality of the plan to help us make those recommendations.
If you have any questions about your investments, including your 401(k) plan, please reach out.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor
Asset allocation is an investment strategy that adjusts the percentage of each holding in an investment portfolio according to the investor's risk tolerance, goals and investment time frame.
One famous industry study indicated that over 90% of the return from an investment portfolio was attributable to the portfolio’s asset allocation. While some have questioned whether or not the percentage is actually this high, there is little question that your portfolio’s asset allocation is a critical factor in determining your return.
Here are some thoughts as to why asset allocation is so important to your investment portfolio.
A key factor in any sound investment strategy is a strong consideration of the investor’s risk tolerance. This might be tied to their age, time horizon, or if the portfolio is needed for a specific goal like retirement.
Asset allocation is a tool to balance the management of the portfolio’s potential downside risk with its potential return through the appropriate allocation to holdings in various asset classes.
One of the basic tenets of long-term investing is portfolio diversification. In a nutshell this means holding a variety of investments that are not all highly correlated to each other. Asset allocation is the most efficient way to set up an investment strategy that accomplishes this for our clients.
For example, bonds have a correlation of -0.20 to U.S. large cap stocks. A correlation of 1.00 would mean that these asset classes were perfectly correlated to each other. A perfect correlation means that the price movements of holdings in the two asset classes would move roughly in lockstep with each other and that these price movements would be influenced by the same market and economic factors.
On the other hand, a correlation of 0.00 would indicate little or no correlation in the price movement or in the factors that influence these price movements.
In the example above, there is a very low correlation between the two asset classes. Additionally, the negative correlation indicates that factors that might push one asset class higher would tend to push holdings in the other asset class lower. As we’ve seen over time, bonds tend to hold up better than equities when the stock market is experiencing a period of correction.
Certain asset classes and individual holdings will outperform others at different points in time. Having a target asset allocation helps investors in that it provides a “starting point” so to speak. A key piece of the portfolio review process is a review of your asset allocation. Is it still in line with your portfolio’s target asset allocation?
Reviewing your portfolio periodically is important. This is typically done quarterly. We discourage clients from looking at their portfolios daily and we feel that rebalancing too frequently may do more harm than good. Reacting to every movement in the market is at odds with the benefits of taking a long-term approach to investing.
Many advisors set a range for the various asset classes within a client’s portfolio. If an asset class falls outside of that range then they will rebalance those holdings back to within the target range. A range of +/- 5 percentage points deviation for the target is common for many advisors.
It’s human nature to want to let an investment that has recorded large gains keep running. This may be fine for a period of time, but invariably these gains will level off or be reduced when the holding turns around and gives some or all of those gains back.
The discipline that an asset allocation target brings to investing is that as one or more asset classes grows to a level that exceeds the target allocation by the stated percentage, a portion of the holdings in this asset class are then sold to bring the overall asset allocation back to within the target allocation range. This helps maintain the balance between the portfolio’s upside potential and it’s downside risk.
Many investors have multiple accounts of different types. This might include taxable accounts, IRAs, a 401(k) or similar workplace retirement account or others. The retirement accounts may be traditional, Roth or both.
While the asset allocation of the various accounts may differ a bit, taking a total portfolio approach to asset allocation is important. This helps you focus on the overall level of investing risk you are taking.
A part of a total portfolio approach includes paying attention to asset location as part of this process. Certain types of investment assets are more tax-efficient if held in one type of account versus another.
For example, stocks or equity ETFs or mutual funds that you plan to hold for a period longer than one year are a good fit for a taxable account due to the preferential tax treatment of long-term capital gains. Taxable bonds, including ETFs and mutual funds that invest in them, may be a better fit for an IRA or other tax-deferred (or tax-free in the case of a Roth) retirement account due to the level of fully taxable income they throw off each year.
Asset allocation is meant to be a target that you try to maintain over time. As a key part of the overall financial planning process, your target asset allocation provides a base point for rebalancing over time when the markets move in one direction or another.
Over time, your target asset allocation will likely change as part of the ongoing financial planning process. As you get older an asset allocation that takes less risk might be appropriate for you. You might also adjust your asset allocation to take less risk if your portfolio performs exceptionally well over a several year period. You may find that you are farther along towards accumulating the amount needed to achieve your goals than your financial plan had called for.
Asset allocation is perhaps the most important part of crafting and implementing an investment strategy. It is also an integral part of your overall financial planning efforts.
If you are looking for a fee-only fiduciary financial advisor who will always put your interests first, please give us a call to discuss your portfolio’s asset allocation or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Investment Advisor
Tina Alteri, CPA, Tax Advisor
