Chapter 1: Tax-Strategies: the basics
Matthew Kenigsberg: There are three basic approaches to tax strategy and qualified accounts. The first strategy is deferral. It means that you avoid income taxes now but pay them later when you withdraw money from your qualified account, which is typically in retirement.
This strategy makes sense if you expect to be in a lower tax bracket in retirement. This might be the case if you expect a big drop in your taxable income or your marginal rate to go down for some other reason, such as a move from a high income-tax state to a low income-tax state. New Yorkers, especially New York City residents, who plan to move to Florida after retirement are a good example of this.
If you expect the federal government to sharply reduce taxes in general, deferral may also make sense for you. In any case, deferral is the strategy people use, whether they know it or not, when they make pre-tax contributions to a traditional 401K or IRA.
The second strategy is acceleration. With this strategy, you pay income taxes now, at today's rates, and avoid them in retirement. This makes sense if you think your marginal income tax rate will go up after retirement, which can happen for a variety of reasons. Here are three.
One, if you are a young investor and you've just started your first real job, you're often in the lowest income tax bracket. So in many, if not most cases, it's likely that you'll be in a higher tax bracket after retirement. Two, if you plan to move from the low income tax state to a high one after you retire, you might wind up in a higher bracket. Residents of Texas who plan to move to California after retirement would be a good example of this.
And three, if you expect the federal government to sharply raise taxes in general, you may think that your income tax rates in retirement are going to be a lot higher than they are now no matter what else happens. In addition, acceleration can make sense for people who max out their contributions to qualified accounts even if they don't expect a drop in their marginal income tax rate. The main option for acceleration is Roth accounts.
The third strategy is a diversification. It calls for some deferral and some acceleration. While it may be clear to some investors that either acceleration or deferral is right for them, for others the situation is murky. They may have no idea, for example, if their marginal income tax rates will be higher or lower in retirement than they are now. Diversification also creates the possibility of using so called tax-smart withdrawals which I'll discuss a little later.
To see how the decision process might work, let's consider a couple of hypothetical scenarios. A
This has just pushed his overall income much higher than it was before, but only for a few years. In any case, he plans to retire soon. After retirement, his income will certainly be much lower and he is likely to be at least one tax bracket lower than his current bracket. So he decides on deferral and opts for pre-tax contributions to his traditional 401K plan.
A surgical resident in her late 20s, right out of medical school, feels confident that her income will rise over a 40 year medical career and that after retirement her income will be much higher than it is now. So she decides acceleration is a good bet and she opts for Roth contributions to her 403B.
An architect in her mid-40s is doing well and has seen her income rise steadily for the last 10 years or so. But she isn't sure this will continue. She doesn't yet have a clear sense for when she'll retire and she really doesn't know what her lifestyle will be like at that time. So she decides to diversify and split her contributions evenly between Roth and traditional accounts.
John Sweeney: So you mentioned Roth accounts, Matt. Greg, can I turn to you and ask what are Roth accounts? They've been around for a while and people have been talking about them a lot more lately. So why are they so interesting to investors today?
Greg Weise: Sure. There's a few reasons for that. In the past, high-income earners were not always able to take advantage of Roth savings options because of the phase-out at certain income limits. In recent years, however, the options for converting traditional IRAs to Roth accounts and the availability of Roth 401K options in the workplace have made them much more accessible.
As of last year, more than 40 percent of workplace retirement plans offer 401K option. And many allow conversions from traditional 401Ks to Roth 401Ks. Because access has changed so much in recent years, this option may be overlooked by some investors.
Chapter 2: Tax-Smart Withdrawals
John Sweeney: Matt, you also mentioned tax smart withdrawals. What exactly does that mean and how should new investors think about that?
Matthew Kenigsberg: Well, we have a progressive tax code, meaning as you earn more taxable income, you live in the higher tax brackets and you have a higher marginal income tax rate. That creates some opportunities for people that understand how this system works.
To greatly simplify, imagine there are just three tax brackets – A, B, and C, with A being the highest, C the lowest, and B in the middle. A progressive tax code means that in many cases, you can end up paying less tax overall if you're in B all the time than you would if you were in A in some years and C in others. By
carefully using a mix of Roth and traditional assets during retirement, many investors can, in essence, stay in B and reduce their overall tax liability.
John Sweeney: So maybe it would help if we could see that concept in action. Greg, could you help us explain how that might work?
Greg Weise: Sure. Let's look at a hypothetical example. Consider a case of the Ryan's, a married retired couple, both age 60. They have $925,000 in their traditional 401K, $355,000 in the traditional IRA, and $228,000 in a Roth IRA. They also have $200,000 in their non-retirement brokerage account.
They're looking to get $120,000 after taxes to spend each year. The idea is that pension payments and social security will cover most of that, starting five years from now when they're age 65. But for the next five years, they want to generate all of the needed income using just the two IRAs. Now they could take withdrawals just from the Roth IRA until it's depleted and then turn to the traditional IRA.
Or they could do the opposite. They could take withdrawals from the traditional IRA and then fall back on the Roth when that's depleted. In either case, they actually fall short of their goal in the fifth year. By using the third option which is to take a mix of pre-tax and tax-free withdrawals from each account, in this particular example, this strategy provides more after tax income.
In fact, if you look at what happens if they take a mix of withdrawals from the Roth and traditional accounts, by thinking strategically and using a mix of taxable income from the traditional IRA and non-taxable income from the Roth, they can keep their non-taxable income in the 15 percent tax bracket. They meet the rest of their income needs with money from the Roth account, which is tax free. By avoiding the higher marginal tax bracket, they're able to reduce their taxes by as much as $25,000 over the first five years of retirement, which is enough to carry them through to the end of the fifth year. It’s important to note in this particular example that the tax rates shown don't exactly apply today. But as we saw earlier, they tend to change from year to year and this concept still applies in today's
environment. In order to use it effectively, you'll just need to adjust to changes in the tax bracket. Be aware that not every investor can benefit from tax-smart withdrawals as the Ryan's did. But it's always a good idea to consider the possibility.
John Sweeney: So we're going to discuss techniques that have the potential to improve your after-tax investment returns and we hope you find these ideas useful. But please keep in mind Fidelity doesn't provide tax advice and everything we're discussing today is for your informational purposes. So before acting on any strategy that involves taxes, investors should consult with their tax professionals.
Chapter 3: The Medicare Surtax
John Sweeney: Let’s talk about the new Medicare surtax. That tax was introduced to help fund the Affordable Care Act. So Matt, can you have – walk us through how that rule works?
Matthew Kenigsberg: Sure. Starting last year, the government began imposing a 3.8 percent surtax on the lesser of your net investment income for the year or the amount by which your modified adjusted gross income or MAGI, exceeds $200,000 for single filers or $250,000 for married couples filing jointly.
John Sweeney: So Greg, what is MAGI, modified adjusted gross income, for tax purposes and how is your tax determined?
Greg Weise: Sure. There's essentially three parts of your modified adjusted gross income. The first part is net investment income – taxable interests, dividends, capital gains, rents, et cetera. The second is wages and bonus, or self-employment income, less any qualified contributions to a traditional or Roth IRA or other qualified account.
Third, MAGI also includes distributions from qualified retirement plans such as traditional IRA or 401K or 403B. Qualified Roth distributions are not included. The calculation of MAGI is more complex than that and you should consult your tax professional on the details but that's the essence of it.
The surtax applies to the lesser of the net investment income or the amount that your MAGI exceeds the thresholds, which are $200,000 for single filers or $250,000 for joint filers.
Here's a hypothetical example of how it would play out. Paul and Anne's MAGI is $372,000, of which $330,000 is wages and $42,000 is net investment income. Their modified adjusted gross income is $122,000 over the $250,000 threshold for married couples filing jointly. They'll owe the 3.8 percent on their $42,000 of net investment income because it is less than the amount that they are over the MAGI threshold.
John Sweeney: So Matt, what does this new surtax mean for investing strategies?
Matthew Kenigsberg: Well ultimately, most increases in tax rates make tax strategies more valuable. This new surtax, along with a higher marginal income tax rates introduced last year, gives high-income investors extra motivation to revisit their tax strategies. Looking specifically at the surtax, investors may want to consider reducing their net investment income.
There are a number of ways to accomplish that. For example, the surtax could change the math for investors considering municipal bonds. In most cases, income from municipal bonds issued by the state of
your residence is not taxable by either the federal government or by your state and is not included in net investment income.
Treasury securities, like treasury bills, notes and bonds – are taxed by the federal government, but not by state governments. But income from most other types of bonds, like corporate bonds, is fully taxable at both the state and the federal level. So other things equal, a corporate bond would have to deliver more interest than a treasury, and a treasury more than a muni in order to leave you with the same income after tax.
With the new surtax, that effect is amplified.
Here's another example. Let's say you have $330,000 in taxable income and live in New York State. That means you pay a 33 percent federal, marginal income tax rate and a 6.85 percent state marginal income tax rate. Now, imagine that you're trying to decide between a New York State muni bond that pays interest of four percent and several comparable taxable options.
To equal the four percent municipal bond’s yield after taxes, you would need a treasury bond paying 5.97 percent or a corporate bond paying 6.41 percent, assuming your state income tax is completely tax deductible at the federal level.
So compared with the muni delivering a four percent yield, a treasury yielding less than 5.97 percent would leave you with less after tax. Similarly, a corporate yielding less than 6.41 percent would also leave you worse off after paying taxes. But all of that is before adding the 3.8 percent surtax to the calculation. When it's added, the relationship between the three different yields changes significantly.
In order to match the munis four percent yield on an after-tax basis, a treasury would need to pay 6.33 percent, up from 5.97. And a corporate, 6.79, up from 6.41. So all other things equal, the imposition of the 3.8 percent surcharge increases the attractiveness of munis relative to other types of bonds. That said, bear in mind that other things are rarely equal. Munis, treasuries, and corporate bonds have different risk profiles and the decision to favor one bond over another should never be made on the basis of its yield alone. Be sure to consider the risks and other characteristics of any type of bond or bond fund before purchasing.
John Sweeney: So you've thrown out a lot of concepts here and a lot of numbers but are there strategies to help minimize the impact of the 3.8 surtax?
Matthew Kenigsberg: Well, along with a slightly greater preference for muni income, investors should also be aware that the 3.8 percent surcharge means that investments without regular distributions may be slightly more attractive relative to those that provide them, at least from a tax perspective.
This is because higher tax rates generally increase the value of tax deferral. And one way to get more tax deferral from a taxable account is to obtain a greater share of one's total return in the form of increases in price, also called unrealized capital gains, instead of dividends, interests or other forms of distributions. That might favor a growth stock or an ETF over a dividend-paying stock or mutual fund. But again, things are rarely that simple. Investors should always be aware of the risk profiles of the investments they consider. In many cases, investments that don't make regular distributions are riskier than those that do. And the extra tax-efficiency may or may not justify the extra risk.
Greg Weise: Also keep in mind their asset location. With higher taxes there's more benefit to being strategic about locating investments that generate a relatively large amount of taxes in accounts that offer the greatest tax advantages. Second, annuities can provide additional tax-deferral options as well.
Chapter 4: Managing Capital Gains
John Sweeney: With last year's strong market rally, many investors had to contend with significant capital gains taxes. That's a plus and a minus. Obviously we like making money, but that means we have to pay taxes on them. So Matt, how can an investor manage the impact of those taxes?
Matthew Kenigsberg: Well, one of the best ways to reduce capital gain taxes is to avoid capital gain realization in the first place. If you have an appreciated security in a taxable account and assuming you make regular, charitable contributions, you may want to consider donating it to charity instead of making your contribution in cash.
If you sell an appreciated stock, bond or shares of a mutual fund and then donate cash to a charity, you have to pay capital gains tax on your sale. But if you donate an appreciated security, as long as you've held that security for at least a year, you can generally get an income tax deduction for the market value and avoid that capital gains tax at the same time. Charities don't pay taxes, so they don't have to worry about the appreciation.
Greg Weise: Here's a hypothetical example to illustrate the potential tax savings for a couple with an adjusted gross income of $500,000 filing jointly, making a direct donation of a long-term appreciated security. In this case, it has a cost basis of $20,000, a long-term capital gain of $30,000. If they sell the stock and immediately paid a little over $7,000 in capital gains taxes, that would leave $42,860 for their charitable donation.
On the other hand, if they donate the security directly to the charity, they avoid the capital gains tax altogether. As a result, the tax benefit of their charitable donation is nearly $10,000 more.
John Sweeney: That makes sense Greg. But if I contribute to a number of charities every year, would I have to give depreciated securities to each one individually? Wouldn't that get cumbersome?
Greg Weise: Well if you're a regular contributor to multiple charities, you might want to consider using a donor-advised fund. Donor donor-advised funds are treated as charities for tax purposes. So when you donate an appreciated security to one of them, you've received the usual tax benefits. The donor-advised fund will then sell the security without any tax consequences to you and allow you to invest the proceeds. You will then have an account that's similar to a Roth in that it can be invested in a variety of different options and doesn't generate any tax liability for you. But unlike a Roth, the distributions from the donor-advised funds go to charities that you select, as long as they're approved by the donor-donor-advised funds rather than back to you. This is a convenient way of making charitable contributions to a list of recipients, including smaller ones that cannot accept donated securities directly.
John Sweeney: So that's an important strategy to remember, but those assets belong to the donor-advised fund, which is a legal charity. You can direct the contributions, but they're no longer your assets to consider when making those donations. So it sounds like there are a lot of great strategies available for people who are committed to making regular contributions. But what about other investors? Isn't there a way to use losses to offset some of those capital gains? Matt, what do you think?
Matthew Kenigsberg: Yes. It's called tax-loss harvesting and it can be a great strategy to limit the impact of capital gains. When you sell securities for a loss, you can use that loss to offset capital gains on other investments. And if you have more losses than gains, you can offset up to $3,000 of ordinary income and you can even carry over your unused losses into future years.
This strategy can be particularly effective if you track your tax lots. Say you buy 50 shares of company A for $50 per share in January of year one. And then another 50 shares for $75 per share in January of year two. Then in January of year three, you decide to sell 50 shares for a price of $60 per share. If you sell the first tax lot of shares, you'll have to pay taxes on the gain of $10 per share, or $500.
If you sell the second lot, it creates a tax loss of $15 per share or $750. You could use this to offset capital gains on other sales or even to offset ordinary income if you didn't have any capital gains in year three. Of course if you make monthly or annual purchases of a number of investments over many years, you can build up a huge number of tax lots. That creates complexity, but also offers a potential to be very selective.
In volatile markets like we have seen this year, you could have the opportunity to book losses than could help with gains down the road. Bear in mind, tax-loss harvesting requires careful record keeping, time
and patience, and it generally also requires that investors find investments similar to the ones they sold in order to avoid unbalancing their portfolios.
Given those challenges, investors who don't enjoy getting into the nitty-gritty or those who are pressed for time may want to consider an investment solution that provides tax-loss harvesting as a part of the offer.
Greg Weise: One last strategy there has to do with timing. Holding on to investments for one year qualifies you for long-term capital gains tax rates. These are capped at 20 percent, while short-term capital gains can be taxed at much higher ordinary tax income rates.
Another timing strategy has to do with mutual fund distributions. Throughout the year, funds collect dividends and interests and realize capital gains and they then must pass those along to shareholders as a taxable distribution. Now the timing of a distribution should be a secondary concern when buying a fund. It's much more important to make decisions based on your needs, risk tolerance and asset allocation strategy.
But if you know a fund makes a distribution payment every December, it may make sense to wait until it has passed to buy in. That's because a fund shareholders all pay equally regardless of when they bought their shares.
Chapter 5: Roth Options
John Sweeney: Allan wrote in to us to ask about specific strategies for gradually converting regular or rollover IRAs to Roth, thinking that this may make sense particularly for the amounts taxed at lower brackets before the minimum distribution requirements kick in at age 70 and a half and possibly understanding when earned income has ended or reduced. So Matt, can I ask you to comment on that one?
Matthew Kenigsberg: Sure. Allan's definitely on to something. In general, conversions of a traditional IRA into a Roth in increments rather than all at once can be beneficial to those who are not in the top federal or state and local income-tax bracket. By keeping an eye on their levels of taxable income, as well as the income tax rate schedules, it's often possible for savvy investors to avoid pushing themselves into a higher tax bracket as a result of their conversion.
And this can reduce the conversion tax cost significantly. It may also be beneficial to convert more in years when taxable income is relatively low. There are a variety of other tactics that may be useful and as always, be sure to consult with your tax advisor before making a decision. If you visit
John Sweeney: We got a question for Jill which I think would clarify something that we said earlier. She asks, "If you can't contribute to open a Roth due to the income cap," – she said I think there is one – "should one consider contributing after tax dollars to a regular IRA?" Greg, you want to take that one?
Greg Weise: Sure. I mean, I'd say that you know in general, if you can't contribute to a Roth and if you're talking about after tax dollars, then generally it's going to be preferential because tax-free growth is always nicer to have than tax-deferred growth. That having been said, there are certainly cases where it does make sense for investors to contribute after-tax money through to traditional IRAs.
And furthermore, the relaxation of the rules that now allow for a conversion of those IRAs has led to a situation where many investors can ultimately get transactions done, although sometimes it takes multiple steps to get where they wanted to go.
John Sweeney: Yes, so the conversion is available without an income cap but the establishment of a new Roth continues to have an income cap. Is that correct?
Greg Weise: Correct. Exactly.
John Sweeney: So one of those strategies – you talked about conversion. It's important to think about conversion over multiple periods, if indeed that's available to you, for two reasons. A, you want to be wary of the tax implications of converting a traditional IRA to a Roth IRA. If the conversion creates an income event and if that income event bumps you into the next tax bracket, you want to be aware of that. The second situation is that you want to pay your taxes from an account other than the account that you're converting.
You do not want to degrade any of your retirement assets by paying taxes with them if you can avoid that. So you want to have cash outside of the account that you're converting. And sometimes people don't have enough cash on hand to pay the tax bill in one fell swoop so they can spread the conversion out over multiple years.
Matthew Kenigsberg: John, I'd just like to reinforce what you said and point out that what he said goes doubly for those who are under the age of 59 and a half. If you use assets from a qualified account to pay for a Roth conversion before age 59 and a half, not only are you – as John said – reduce the amount of retirement assets that you've got, but you're also in all likelihood, going to subject yourself to a tax penalty. So it's rarely advantageous to use qualified assets to pay for the Roth conversion. It generally is advantageous to use taxable assets. But that's doubly true for those under the age of 59 and a half.
Chapter 6: Do Annuities Make Sense?
John Sweeney: Greg, can I ask you about deferred variable annuities and when you consider the annuity cost, does it make sense to use a variable annuity to accumulate gains tax-free? What do you think?
Greg Weise: Sure. In many cases, the deferred variable annuity, or DVA, can be a great way to, in essence, buy additional tax deferral. You should always first take advantage of whatever tax-deferred accounts you may already have, like 401Ks, Keogh plans, and IRAs. But if you've already contributed to those accounts up to their limits, a deferred variable annuity might make sense.
For those who have maxed out, here's three things that you may want to consider in order to determine whether a deferred variable annuity may be beneficial. First, is the presence inside taxable accounts of assets, like U.S. high-yield bonds or real estate investment trusts that throw off a lot of fully taxable income. These assets tend to be very tax-inefficient and therefore, it's often beneficial to sell and replace them with similar investments inside of deferred variable annuity.
The second indicator is an expectation of a declining marginal income tax rate. The bigger the expected fall in the tax rates, the bigger the potential benefit of a deferred variable annuity. People tend to think that declining tax rates can only happen as a result of a decline in taxable income. But it can also be the results of a move after retirement from a domicile with very high state and local income taxes, like New York City, to one with no state, or low state and local income taxes, such as Florida.
The third indicator is an investment horizon of at least 10 years. The benefits of tax deferral generally take time to accumulate. So investors with short time horizons generally don't benefit very much from it. That said, these indicators are not fool-proof and as you mentioned, the benefits of the deferred variable annuity, have to be weighed against the costs.
In addition to the fees, variable annuities are generally inappropriate for assets that you'll need before age 59 and a half because withdrawals before that point are usually penalized. So be sure to weigh the pros and cons carefully before proceeding.
John Sweeney: Greg, we got a question here from Rob and he said “are annuities inside an individual retirement account considered tax-free?”
Greg Weise: There's a difference between the investment vehicle and the investment themselves. So what you'll find is that the nature of the retirement account itself is actually going to determine the taxation.
Historically, including an annuity in the account is something that you've got to think very carefully about because annuities do have charges and fees that are historically associated with tax deferral.
So in a certain sense, you already have a tax-deferred account. The question would be, what additional value do I get by including an annuity in here? Generally, the additional tax deferral is not going to be valued because it already is a tax-deferred account. So there would have to be other reasons to include an annuity inside of an account like that.
John Sweeney: So it's sort of like buying a municipal bond which is a tax-exempt security, inside an IRA, which is not something we'd recommend. Is that correct?
Greg Weise: Sure. Or going out in the rain with two umbrellas.
Operator: Before investing, consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Call or write to Fidelity or visit Fidelity.com for a free prospectus and, if available, a summary prospectus containing this information. Please read the prospectus and consider this
information carefully before investing. Product availability and features may vary by state. Please refer to the contract prospectus for more complete details regarding the living and death benefits.
Chapter 7: The Tax-Efficiency of Different Investments
John Sweeney: Matt, I want to talk to you about exchange-traded funds. That's a product that we get a lot of questions about. And what metric can an investor use to judge the tax-efficiency of a particular mutual fund or an exchange-traded fund?
Matthew Kenigsberg: Well, there's no way to know for sure how efficient a fund or an ETF is going to be in the future. But Morning Star provides a tax/cost ratio measure that provides a lot of useful information about the historical tax drag for many popular products.
John Sweeney: So in general, what would indicate a higher tax drag than a lower tax drag? What would create that? Matthew Kenigsberg: Well, as a rule, you will find that taxable bond funds tend to have very large tax drags because they
distribute fully taxable income. Amongst equity products, you will find there's a lot of variability. But as a rule, funds that have higher turnover rates tend to also have higher tax/cost ratios. It's not an iron law, but it does tend to hold in general.
You'll also find that REIT funds tend to have very large tax drags because as some people know, REIT funds do not distribute qualified dividends, they distribute fully taxable income. And that means that what comes out of a REIT fund is treated for tax purposes exactly the same as your salary or as income that might come from a taxable bond fund. So REITs tend to be very, very tax inefficient. But again, those are just some generalizations. Each fund can have a different tax profile from the next. So it's important to check on the specific fund or ETF that you have in mind.
John Sweeney: So your representative can help you determine which ones might be appropriate for which accounts. We see a lot of customers come in asking about how to generate higher income in this low interest rate environment and REITs are one of the places that they ask us about. So it's important to consider how much you keep after you pay your taxes when buying a fund like that.
Matthew Kenigsberg: Absolutely. Absolutely. That should always be a part of the consideration when you're looking for income.
Chapter 8: Withdrawal Options
John Sweeney: We got a question here from Daniel and he said, "I'm recently retired. I have a mix of investments in a tax-deferred account, for example an IRA, and some non-deferred accounts. What would be the best strategy for withdrawing cash from those various investments? Should I take the dividends instead of reinvesting them or should I sell the shares?” Greg, can I ask you to start with that one since it's similar to one of the examples that you referenced earlier in the call?
Greg Weise: Sure. It's a great question and obviously it gets into, you know, some personal details very quickly in terms of considering all the different aspects of your financial situation. I would like to make the general comment, though, that I think a lot of times people have this idea in their mind of a certain way they get to retirement and they're going to do all one thing or all the other.
You know I'm going to drop all my – I'm going to take all my money from this account. I would say that just historically and the way that we approach planning, it does make sense in a lot of cases to diversify. Now of course, in this particular circumstance, I can't say exactly what would make sense. But a lot of times it makes sense to put together an income strategy that's going to enable you, certainly allow you, to take money from different places that's going to be taxed differently.
Not only would that be true at the account level – so for example, potentially taking money from a combination of my IRA accounts and my taxable accounts as we discussed earlier – but it's also going to hold true at the investment side. Same thing when you're looking at you know should I take it from my stocks? Should I take it from my bonds? And of course you know there's a lot of thought that needs to go into that. But I would say fundamentally, it makes good planning sense to have a diversified approach in this situation.
John Sweeney: When you think about different account structures, we often see customers who get to the point of retirement and say, “I've saved enough money in my 401K. I should begin withdrawing that, right. That's the money I've saved for retirement.” Is that the first place that investors should look to withdraw money in most cases? Matt, your thoughts on that?
Matthew Kenigsberg: I would say that, unfortunately, that's one of those where I have to answer with "it depends". There are a lot of instances where it makes sense to try to defer taxes as long as possible. That is true in many instances. But there are, unfortunately, lots of exceptions. I would say that in particular, the exceptions is something to look out for when estate planning is an important part of the mix.
So one thing right off the bat that I can raise as an issue is for investors who are concerned about a taxable estate – and obviously that's only a small percentage of investors, but for those who are concerned about a taxable estate, a lot of rules that might otherwise be – that might apply, would not. That's the first thing to look out for.
There are other things that would apply. If, for example, a 401K has a lot of basis inside it – that is, there have been non-qualified contributions, that can also change the mix. It might also – it might or might not indicate that a Roth conversion would be a good idea. So as much as one would like to generalize, I think you have to be very careful about that.
Is it true that as a rule you want to try to defer taxes as long as possible? Yes. Isn't it true that increasing the length of the deferral tends to increase the benefit of deferral? Yes, that is true. But I would at the same time point out that estate planning can change that. The presence of basis inside a 401K can change that. And so can some other factors. So unfortunately, when it comes to the withdrawal hierarchy, as we call it, you've got to be careful and look out for those generalizations.
John Sweeney: We've got a question here from Sandy and Sandy asks, "Does it make sense to convert part of a traditional IRA to Roth to reduce taxes once I get to 70 and a half and I'm forced to take the minimum required distribution?" Sandy expects to substantially increase income at that time.
Matthew Kenigsberg: Well I can say that – and again, I would encourage you to check with your tax advisor to make sure that all of your strategies are viable from a tax perspective. But it is my understanding that Roth conversions will not cover minimally required distributions. So if you want to make a Roth conversion that goes beyond the minimum required distribution, then use some of the assets that did come out as a result of the minimum distribution in order to pay for the Roth conversion.
That may be a viable strategy, but it does depend on a lot of outside factors. But again, I wanted to emphasize that you need to check with your tax advisor. Make certain that you've met all of the conditions for minimum required distribution because failing to meet the requirements for minimum required distribution can subject you to very harsh penalties. So it's very important to avoid those. John Sweeney: If you're close to 70 and a half, you can talk to your account executive and they can help you set up a
minimum required distribution program that, when it's set up, automatically makes sure that you get paid and take the right withdrawals so that you don't run afoul of those tax laws because they are onerous, the
calculations are somewhat complicated and you want to make sure that you're doing it in the right way so that you don't end up not withdrawing income and thereby, paying a penalty.
John Sweeney: We also had a question from Charles. He said, "My wife and I will be 62 this year. Is it better to defer taking social security until 66 and take a larger IRA withdrawal now?"
Matthew Kenigsberg: It's very, very common for people to want to start taking social security as soon as they are capable. We see a very large number of people who start taking their distributions at 62 – as soon as they're eligible. But what you have to understand is that, in general – and there are exceptions – but in general, taking social security distributions from a very, very early age is, in essence, expressing a view that you don't expect to live a very long time, at least from a financial perspective.
Because generally speaking, if someone is going to be very long lived and live into their 90s or older, in general, it's going to be advantageous for them to not start taking their distributions early. It's going to generally be advantageous for people who do live a long time to start taking their distributions as late as possible.
On the other hand obviously, if someone is unfortunately suffering from a terminal illness, that might be a very good reason to start taking their distributions early. So again, what it really boils down to is taking distributions early, from a financial perspective – from a strictly financial perspective – is simply an expression of, I don't expect my longevity to be very great and if I were to wait, then I would not receive very many distributions, even if those distributions were somewhat larger.
Taking social security as late as possible is an expression of an expectation of greater longevity because if you start taking distributions late and those distributions are large, you will compensate for the
distributions you did not receive earlier if you live a long time. That's something you might want to talk to a rep about and you also, of course, may want to think very seriously about your health before you make a decision. It's difficult, of course, to predict longevity, but there are some indicators that you can use as a guide.
John Sweeney: Family history is one of those examples. You look at the ages of your parents and grandparents, when they passed away and those are good predictors of, perhaps, family history. Certainly your own health may be different. But longevity is one of the risks that investors face in retirement and social security is a great mitigator to that longevity risk in that it's a life time income stream.
About every year that you defer taking social security, you get about an eight percent increase in the annual payments. So to Matt's point, if you defer the collection of social securities, you can count on somewhat higher revenues each year that you defer and those income streams last for your lifetime. So two important considerations when you're structuring an income plan.
Operator: The information presented reflects the opinions of John Sweeney, Matthew Kenigsberg and Gregory Weise as of March 4, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization and are subject to change at any time based upon market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and because investment decisions for Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund. As with all of your investments to Fidelity, you must make your own determination whether an investment of any particular security or fund is consistent with your investment objectives, risk tolerance, financial situation and your evaluation of the investment option.
Fidelity is not recommending or endorsing any particular investment option by mentioning it in this conference call or by making it available to its customers. This information is provided for the educational purposes only and you should bear in mind that laws of a particular state or your particular situation may affect this information.
Diversification, asset allocation does not ensure a profit or guarantee against lost.
Keep in mind that investing involves risks. The value of your investment will fluctuate over time and you may gain or lose money. Past performance is no guarantee of future results. The stock markets are volatile and can decline significantly in response to adverse issuer, political regulatory, market or economic developments.
In general, the bond market is volatile and fixed-income securities carry interest rate risks. As interest rates rise, bond prices usually fall or vise-versa. This effect is usually more pronounced for long term securities. Fixed income securities also carry inflation risks, liquidity risks, call risks and credit and default risks for issuers and counter parties. Unlike individual bonds, most bond funds do not have a maturity date. So avoiding losses caused by price volatility by holding them until maturity is not possible. The municipal market can be affected by adverse tax, legislative, and political changes, and the financial condition of the issuers of municipal securities.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or a tax professional regarding your specific situation.
Fidelity Brokerage Services LLC is a member of the New York Stock Exchange, the SIPC and is headquartered at 900 Salem Street in Smithfield, Rhode Island, zip code 02917
Keep in mind that investing involves risks. The value of your investment will fluctuate over time and you may gain or lose money. Past
performance is no guarantee of future results. The stock markets are volatile and can decline significantly in response to adverse issuer, political regulatory, market or economic developments.
Before investing, consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Call or write to Fidelity or visit Fidelity.com for a free prospectus and, if available, a summary prospectus containing this information. Please read the prospectus and consider this information carefully before investing. Product availability and features may vary by state. Please refer to the contract prospectus for more complete details regarding the living and death benefits.
The information presented reflects the opinions of John Sweeney, Matthew Kenigsberg and Gregory Weise as of March 4, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization and are subject to change at any time based upon market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and because investment decisions for Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund. As with all of your investments to Fidelity, you must make your own determination whether an investment of any particular security or fund is consistent with your investment objectives, risk tolerance, financial situation and your evaluation of the investment option. Fidelity is not recommending or endorsing any particular investment option by mentioning it in this conference call or by making it available to its customers. This information is provided for the educational purposes only and you should bear in mind that laws of a particular state or your particular situation may affect this information.
Diversification, asset allocation does not ensure a profit or guarantee against lost.
In general, the bond market is volatile and fixed-income securities carry interest rate risks. As interest rates rise, bond prices usually fall or vise-versa. This effect is usually more pronounced for long term securities. Fixed income securities also carry inflation risks, liquidity risks, call risks and credit and default risks for issuers and counter parties. Unlike individual bonds, most bond funds do not have a maturity date. So avoiding losses caused by price volatility by holding them until maturity is not possible. The municipal market can be affected by adverse tax, legislative, and political changes, and the financial condition of the issuers of municipal securities.
The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.
Exchange traded products (ETPs) are subject to market volatility and the risks of their underlying securities which may include the risks associated with investing in smaller companies, foreign securities, commodities and fixed income investments. Foreign securities are subject to interest rate, currency-exchange rate, economic and political risk all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector are generally subject to greater market volatility as well as the specific risks associated with that sector, region or other focus. ETPs which use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses and tracking error. An ETP may trade at a premium or discount to its Net Asset Value (NAV) (or indicative value in the case of ETNs). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile which is detailed in its prospectus, offering circular or similar material, which should be considered carefully when making investment decisions.
Changes in real estate values or economic conditions can have a positive or negative effect on issuers in the real estate industry, which may affect the fund.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or a tax professional regarding your specific situation.
