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Tax-Coordinated Portfolio Disclosure Statement

The value provided by Tax-Coordinated Portfolio (“TCP”) will vary depending on each investor’s personal circumstances. Investors who have a short time horizon, rely on tax-deferred (rather than tax-exempt) accounts, and expect to be in a high income tax bracket in retirement may get little to no value from the asset location strategy employed by TCP. Under certain circumstances, investors could conceivably even decrease their after-tax returns by enabling TCP.

As a general matter, asset location strategies like the one implemented by TCP distribute assets unevenly across multiple accounts based on the varying return profiles of each asset (separately considering the potential for capital appreciation and dividend yield). These figures are “expected returns”—projections for what future returns might be. While these figures are empirically derived (using Black-Litterman methodology) they are still speculative, and actual returns will differ year-to-year, often substantially.

Therefore, while the reasonable expectation may be that asset A will pay more dividends than asset B (and/or appreciate more than asset B), the opposite could happen in any given year, or across a number of years, such that asset location decisions based on differing expectations do not maximize after-tax returns. The longer the investing period, the more likely it is that the relative performance of the various assets in the portfolio will converge on what is expected. Shorter periods, however, are more likely to produce unexpected results.

Asset location seeks to place assets with higher expected returns into tax-advantaged accounts. Therefore, towards the end of the accumulation phase, an investor should expect his or her tax-advantaged accounts to have a higher balance than they otherwise would have been (and the taxable retirement account to have a lower balance than it would have been, had an asset location strategy not been deployed).

While under most circumstances, more growth in a tax-advantaged account (in exchange for less growth in a taxable account) is desirable, there are potential trade-offs which should be considered. For instance, tax-advantaged accounts incur penalties for early withdrawal, so to the extent that access to funds prior to retirement becomes necessary, liquidity may come at a higher cost for a portion of funds that might otherwise be accessible penalty-free (had that appreciation taken place in the taxable account instead).

If the tax-advantaged assets are primarily or exclusively tax-deferred, rather than tax-exempt (e.g. a traditional IRA vs. a Roth IRA) then additional considerations should be weighed. Because all distributions from a tax-deferred account are taxed at ordinary rates, including amounts that would be taxed as long-term capital gains when realized in a taxable account, shifting such appreciation could amount to a conversion of lower taxed income into higher taxed income.

Over a long enough period, the tax deferral (i.e. the ability to continually reinvest the tax savings and compound that growth, before eventually paying the tax) is expected to be valuable enough to justify such a conversion. This is especially likely when the taxpayer expects to be in a lower income tax bracket in retirement than during the accumulation phase (often, though not always the case). However, when asset location is practiced over a short period (years, not decades) and the taxpayer maintains a high income tax bracket at the time of distribution, conversion of some capital gains into ordinary income may dominate the after-tax return, thereby rendering the asset location strategy counterproductive.

As a separate matter, a higher tax-deferred balance could mean higher required minimum distributions (“RMDs”) in retirement, which could be an important consideration for those seeking to minimize their RMDs.