A Tax-Savvy Way to Bolster Your Retirement
Jen Ryan
12/04/06 - 10:37 AM EST
It can be difficult to stow away as much as you'd like for your golden years through qualified retirement plans.
Contributions to individual retirement accounts are currently capped at $4,000 a year. For employer-sponsored plans such as 401(k)s, 403(b)s or 457s, the maximum is $15,000 for people under the age of 50. (People over 50 can contribute an additional $1,000 a year.) For many nearing retirement, particularly those who weren't able to save a lot early on, this just isn't enough.
Eaton Vance is stepping into the void with a new Web-based product called a supplemental retirement account, or SRA -- a taxable account that can be used alongside qualified retirement plans to scale up retirement savings with minimal tax consequences.
When you open an SRA -- it requires an initial minimum investment of $20,000 and monthly contributions of at least $500 -- you're given a choice of five preset portfolios made up of tax-managed stock funds and tax-exempt municipal income mutual funds. You also have the option of creating a customized portfolio by mixing and matching funds. There is $30 one-time set-up fee and a $30 annual maintenance fee in addition to the management fees associated with the underlying mutual funds.
There are eight tax-managed equity funds to choose from, 33 long-term municipal bond funds, eight limited-term municipal bond funds and a tax-free cash reserve fund, all of which are managed by Eaton Vance.
When you enroll in the program, you're asked to choose a "target date" for your account that corresponds to the year you expect to retire. In addition, you're asked to choose an initial asset allocation and a target asset allocation that you'll reach when you hit your target date.
Between the time you sign up and your target date, the asset allocation will shift. Here's how: SRA uses software that constantly evaluates portfolio positions against your target. Monthly contributions are allocated to the appropriate funds to keep the portfolio aligned with the target. Likewise, if you make withdrawals, positions are chosen to be liquidated that will move the asset allocation toward the targeted portfolio weightings.
As with the target maturity or life-cycle funds available in many retirement plans, the idea is that your asset allocation gets more conservative as you near retirement. "This is similar to that, in that it has that same aspect of that dynamic asset allocation," says Thomas Faust Jr., president and chief investment officer of Eaton Vance.
Faust adds that using cash flows to shift asset allocations is more tax-efficient than rebalancing by selling positions that are overweight in order to add to underweight positions.
Minimizing taxes can have a big impact on your portfolio's returns, particularly when you take into account the impact of compounding.
According to a recent study by Lipper Research, taxes are the single biggest drag on the performance of equity mutual funds held in taxable accounts. The study shows that over the past decade, the average stock fund gave up 1.6 percentage points in annual return and the average taxable bond fund gave up 2.4 percentage points in annual return to federal taxes on distributed income and gains. Those figures don't take into account state and local taxes, which can act as a further drag on performance.
"If we can save [those costs], it is an enormous benefit," Eaton Vance's Faust says.
John Blamphin, retirement income specialist and investment advisory representative with Retirement Strategies of Maryland, notes that many of the program's features, such as systematic savings, asset allocation and a range of preset portfolios, are already available in the retirement marketplace; the interesting twist is the dynamic asset allocation
He expects other fund companies to develop similar products. "I think you'll probably see a trend in this direction ... companies trying to make it as easy as possible to invest with them and make it easier for the adviser."
Blamphin does note a potential drawback: By limiting themselves to tax-managed funds in this program, investors may be sacrificing higher returns available elsewhere. "If I'm putting together a tax-managed portfolio for someone, I'm probably going to be looking at tax-equivalent yield," he says, adding that some taxable investments can generate higher returns than tax-managed equity funds and tax-free bond funds, even when the impact of taxes is taken into account.
