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3.8% net investment income tax
Where does the money grow?
What a taxable managed account really earns
From the portfolio's gross return to what the client keeps, one cost at a time.
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Returns are annualized internal rates of return on the client's own deposits. Each line is measured by rerunning the full projection with that cost added, so it includes the growth the lost dollars would have earned.
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Same savings, three tax treatments
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Tax-free account type
Life insurance: what the policy costs
How it works
Each year, in order. Deposits are added (at the start of the year). The portfolio earns its gross return: qualified dividends and interest are paid out and reinvested, and the rest is price growth, reduced by fund expenses. The manager then realizes the turnover share of all unrealized gains, split between short- and long-term. The advisory fee is charged on the average balance for the year.
Taxes in the taxable account. Interest, non-qualified dividends and short-term gains are taxed at the federal income tax rate. Qualified dividends and long-term gains are taxed at the federal capital gains rate. The state rate and, if it applies, the 3.8% net investment income tax are added to both. Fees and taxes are paid by selling shares, which lowers cost basis pro rata and realizes the gain on the shares sold; that gain is taxed too. Advisory fees are not deductible for individuals under current federal law.
At the end. If the account is sold, remaining unrealized gains are taxed at long-term rates. If it is held until death, heirs receive a stepped-up basis and no income tax is due on those gains; estate tax may still apply.
Tax-deferred (401(k), IRA, annuities, other deferred compensation plans). Same investments, fees and expenses, with no tax until withdrawal; gains are then taxed at the federal income tax rate plus state tax, and the 3.8% tax if it applies (it applies to annuities, not to IRAs or 401(k)s). This models after-tax money, as in an annuity. Traditional 401(k) and IRA contributions go in before tax, so the whole withdrawal is taxed. Withdrawals before age 59½ may also carry a 10% penalty. Annuity contract charges are not included.
Tax-free (Roth accounts, 529 plans, municipal bonds, cash value life insurance). Same investments, fees and expenses, with no income tax when the rules are met: Roth age and holding rules, 529 money spent on qualified education, municipal bond interest (not gains; state tax may apply), and life insurance accessed through policy loans and withdrawals while the policy stays in force. Each has limits and its own costs, such as insurance charges, that are not included here.
Simplifications. Returns are the same every year. Taxes are paid in the year earned rather than the following April. No tax-loss harvesting, capital loss carryforwards, alternative minimum tax or SALT limits. Tax brackets are applied as flat rates.
This is a hypothetical illustration of mathematical principles and does not represent any specific product, manager or investment. Rates of return are not guaranteed and will vary; actual results will be higher or lower. Tax rates and rules are simplified and subject to change.
This material includes a discussion of one or more tax-related subjects. It is not intended and cannot be used by any taxpayer for the purpose of avoiding any IRS penalties. Clients should consult their own tax and legal advisors.