Tax & Fees
The costs that decide a client's net return: the fee compounded over decades, tax on income and where to hold it, which account to save in, and turning a loss into a deduction.
Markets are uncertain; costs are not. The fee, the tax on income, the account a contribution goes into and the losses that are or are not harvested are the parts of a client's return an advisor actually controls, and interviewers test whether you can put numbers on each. This lesson takes them in the order they are met: the fee every year, the tax on the income the portfolio throws off, the tax on the contribution and the withdrawal, and the deduction a losing position can become.
One habit runs through every chapter: compare after tax and after fees, on the client's side of the ledger. A fee is judged against the gain, not the portfolio. A yield is judged after the client's marginal rate. An account is judged by what comes out after tax, not what goes in. A harvested loss is judged by the deferral it buys, not the deduction it prints.
- Fees. The net factor (1 + g)(1 − fee), the share of wealth lost whatever the market does, and the alpha that would justify a fee.
- Income. Taxable-equivalent yields, the break-even tax rate, state tax, and why munis belong outside the IRA.
- Accounts. Traditional against Roth: the growth cancels, the two tax rates decide, and capped contributions favour the Roth.
- Losses. Harvesting in the right order, the carry-forward, the deferral's value and the wash-sale rule.
Multiply the factors, and put each tax at the end where it is charged. A fee is a factor of (1 − fee) every year; a tax on income is a factor of (1 − t) on the yield; a tax on a contribution or a withdrawal is a factor of (1 − t) at that end, and the order of factors does not matter. Asset location, which account holds which asset, is the recommendation that falls out of all four chapters.
The costs, in the order a client meets them
Each step points to the chapter that practices it.
Chapters
The fee, every year
11 minA 1% fee is 1% of the money every year, and each year's fee also removes the growth that money would have earned for every year after.
- Compound a return and a fee together over many years
- Show the share of ending wealth a fee removes, whatever the market does
- Find the highest fee a wealth-loss limit allows
- Compute the outperformance an active fund needs just to match an index fund
Income, tax, and where to hold it
10 minA muni yielding 3.5% can beat a corporate at 5%, because the client keeps all of the first and part of the second. The break-even tax rate turns the comparison into one question.
- Gross a tax-free yield up to its taxable equivalent
- Find the tax rate at which a muni and a corporate bond tie
- Compare after-tax income in dollars, with and without state tax
- Say why a muni inside an IRA is a mistake
Which account to save in
11 minTax now or tax later: multiplication does not care about order, so the decision is a bet on one number, the client's rate today against their rate in retirement.
- Compute after-tax values for a traditional and a Roth contribution
- Show the winner depends only on the two tax rates
- Back out the tax rate paid on a Roth contribution
- Say what changes when the contribution is capped
Turning a loss into a deduction
12 minSell a losing position, buy something similar, and the paper loss becomes a deduction without changing the exposure. What it really buys is time.
- Apply a harvested loss against gains, then income, then carry the rest forward
- Find the loss needed to cut a tax bill by a given amount
- Value the deferral when the tax comes back later
- Say what the wash-sale rule allows and what it does not