Tax-Deferral Becomes More Urgent As Congress Seeks Fiscal Solutions

Many Americans began the New Year relieved that the “fiscal cliff” had been averted, if only temporarily. But there is no escaping their biggest fear—that an increase in their federal tax bill is inevitable. Congress continues to hammer out the final details, but one thing is certain: anyone drawing a salary or receiving other income will be hit with more taxes. And the higher their income, the bigger the bite.

The situation becomes even more challenging because taxes are rising at a time of increasing volatility. Since the crash of 2008, wild swings in the market have become the norm, and show no signs of abating. As we’ve seen in recent months, uncertainty in Washington sends Wall Street into a tailspin weekly, if not daily.

In a study by Cogent Research, 70% of Registered Investment Advisors (RIAs) surveyed say ongoing volatility is a top concern for their clients1. For many, the solution is using more liquid alternatives and tactical management. In a survey conducted by Jefferson National, 68% of advisors indicated they have already increased their use of alternative investments, and most expect to continue increasing their allocation to alternatives over the next 5 years, as they anticipate ongoing volatility2.

While liquid alternatives and tactical management have proven effective for managing volatility and optimizing risk-adjusted performance, one of the biggest obstacles to using them is that they tend to be highly tax-inefficient. So it comes as no surprise then that a new survey of RIAs and fee-based advisors released by Jefferson National last month found that 85% say a low-cost tax-deferred investing solution would be beneficial to clients in a time of rising taxes—and in a time of ongoing volatility.

After-tax return—or what’s left in an investor’s pocket at the end of the day—is the true yardstick to measure performance. For many, optimizing after-tax returns begins by consulting with an advisor to discuss the concept of “asset location,” a strategy to determine which assets in the portfolio should be located in taxable vehicles and what portion should be tax-deferred.

In an environment where taxes are rising and every basis point of yield matters, it’s important to pay close attention to the tax-efficiency of investments. Certain asset classes and strategies are tax-inefficient because they generate short term capital gains or ordinary income, which are taxed at higher rates. These include any actively managed funds or strategies, as well as most liquid alternatives, taxable bond funds, commodities and many other non-correlated assets. Typically, it’s best to “locate” these tax-inefficient investments inside a tax-deferred vehicle3, provided you don’t run into high fees, low contribution limits or limited fund selection.

The first step in an asset location strategy is to maximize contributions to qualified plans such as an IRA or 401(k). Investors not only postpone paying taxes on the money they contribute, they also postpone paying taxes on investment gains to make the most of tax-deferred growth. It’s especially important to maximize 401(k) contributions when employer matching is available—in essence, that’s found money.

For aggressive savers and high net worth investors who can easily max out the low contribution limits of qualified plans, a low-cost, no-load variable annuity is an important option—one that is often overlooked. But in recent years, a new breed of VAs have been designed exclusively for tax-deferred investing—with low fees, greater transparency, and more fund choices, while stripping away commission and complex insurance components. Jefferson National pioneered the concept and has re-engineered a VA to serve as a tax-deferred investing solution specifically for RIAs, fee-based advisors and their clients, with a unique flat-fee pricing4 and more than 390 underlying funds, including more liquid alternatives and tactical strategies. Although this type of product is far from the norm in the industry, it has been adopted by more than 2,000 advisors we serve, becoming an important part of their practice and a key component of their clients’ portfolios.

Research shows that small investors often look at the return on an investment, but overlook how taxes can erode those returns. Morningstar estimates that over the 74-year period ending in 2010, investors who did not manage investments in a tax-sensitive manner gave up between 100 and 200 basis points of their annual returns to taxes. This is another reason why tax deferral is so relevant today. A low cost tax-deferred investing solution can help investors manage the impact of taxes to increase returns —without increasing risk.

While the “fiscal cliff” may have been averted for now, it is still too soon to tell what the permanent solution to our nation’s fiscal crisis will be or how negotiation over the debt ceiling will pan out. And there is no avoiding the mounting federal budget deficit, which has topped $1 trillion for four consecutive years; the massive national debt, which today stands at more than $16 trillion; and continuing uncertainty about economic growth. But in a complex environment of rising taxes, increasing volatility and unprecedented low rates, it’s important to know there are tax-deferred investing solutions with the right cost structure and the right fund choices to help investors manage risk, maximize after-tax returns and accumulate more wealth to meet their retirement goals.

Mitchell H. Caplan is a recognized leader and advocate for innovation in the financial services industry. As Chief Executive Officer of Jefferson National, Mr. Caplan has led the company to growth of more than 50% year over year. Previously, he served as CEO and Director of E*TRADE Financial Corporation. Under his leadership, from 2003 through 2006, E*TRADE reported four consecutive years of record revenues and earnings. For more information, please visit or call 1-866-WHY-FLAT (866-949-3528).

1"The RIA Market Research Study," conducted for Invesco by Cogent Research, September 2011.

2"RIAs and Fee-Based Advisors Alternative Investments and Tactical Management Survey" published by Jefferson National, September 2011.

3 Upon withdrawal, earnings will be taxed as ordinary income.

4 Jefferson National’s Monument Advisor has a $20 monthly flat insurance fee. Additional fees ranging from $19.99-$49.99 will be assessed for investors wishing to purchase shares of ultra low-cost funds. See the prospectus for details.

Important Disclosure:

An investor should carefully consider the investment objectives, risks, charges and expenses of the investment before investing or sending money. The contract prospectus and underlying fund prospectuses contain this information. For a prospectus containing this and additional information, please contact your financial professional. Read it carefully before investing. The summary of product features is not intended to be all-inclusive. Restrictions may apply. The contracts have exclusions and limitations, and may not be available in all states or at all times.

Variable annuities are investments subject to market fluctuation and risk, including possible loss of principal.

Variable annuities are long-term investments to help you meet retirement and other long-range goals. Withdrawal of tax-deferred accumulations are subject to ordinary income tax. Withdrawals made prior to age 59 ½ may incur a 10% IRS tax penalty.

Monument Advisor is issued by Jefferson National Life Insurance Company (Dallas, TX) and distributed by Jefferson National Securities Corporation, FINRA member. Policy series JNL-2300-1, JNL-2300-2.


© Jefferson National

Read more commentaries by Jefferson National