New clients at Telarray are offered a session at the beginning of our relationship to discuss the Telarray approach to investing. It’s a lot to process, and we know there may be questions as our relationship develops.
Of course, you may call your Advisor at any time, but we thought a multi-part series discussing our approach to investing might be helpful. Last time, we discussed the types of funds we hold in Telarray portfolios. Below you’ll find the third part of this series, in which we discuss the different types of accounts used to hold your assets at Telarray.
New investors are often surprised and confused by the wide variety of types of accounts that may be opened on their behalf. As careers stretch from years into decades, some investors accumulate various types of accounts in different places and lose track of what they have. This is a brief review of the most common account types we use to build long-term portfolios at Telarray.
These are accounts that any adult can open and are generally the default place to invest new money when no better option is available. Any interest or dividend income is taxable in the year it is received. Buying investments is not a taxable event, but each time a security is sold, the difference between sale proceeds and the original cost of the investment is known as a capital gain (or loss), which is taxable. If there is more than one owner of the account, the registration most likely will contain the term JTWROS (though there are other options). JTWROS means Joint Tenants With Rights of Survivorship, meaning if one of the joint owners dies, the other owner seamlessly gains control of the account without the probate process. This is one of the only account types that allows for joint owners at all. Most other types of accounts can have only one owner.
This is a tax-friendly type of account that defers taxes into the future. When this type of account is funded, the contributions are excludable from taxable income. In other words, if you contribute $1000 to an IRA and your marginal income tax rate is 20%, then that decision means you have $1000 to invest in your IRA and you also get an extra $200 in your tax refund (or pay $200 less in taxes than you otherwise would). As the account grows, you don’t have to pay taxes on dividends, income, and capital gains. Once you reach retirement age, you can pull money out of your IRA with no penalties, but you are subject to income tax on the entire amount you withdraw.
Roth IRA/Roth 401(k)
This is a tax-friendly account that’s like a traditional IRA but in reverse. The contributions are not excludable from income, so a $1000 contribution today results in no current tax benefit. From there, the account grows free from tax on capital gains, dividends, and interest. The real benefit to a Roth account comes after retirement age, when withdrawals can be taken completely tax-free. Generally, the decision between funding a Traditional and Roth account hinges on current tax brackets vs. expected tax brackets in retirement. With some assumptions, investors should be ambivalent about which account to choose if current rates and expected retirement tax rates are the same.
There are some variations of the names of this type of account, but generally UTMA (or Universal Transfer to Minors Act) accounts are a way to put money in the name of a child for the future. These accounts have no specific tax benefit other than the fact that children often don’t have any other income. Therefore, the taxable events in the account — like capital gains and dividends — usually don’t trigger any actual tax due unless the account is large. A custodian (often a parent) is appointed as part of the account setup process. The custodian directs the investments and any other decisions that must be made on the account until the owner reaches adulthood, and the account must be managed and used solely on behalf and for the benefit of the minor. The potential downside to this type of account is that children can fully access and direct the account (including spending every bit of it on things that might seem frivolous) the moment the child turns 21.
Trusts are typically set up by an attorney and are created to accomplish a wide variety of goals; there are countless types of trusts. Trusts can be set up to preserve generational wealth or more efficiently give money to charity. They can be set up to receive more favorable tax treatment or be set up solely to pay taxes on behalf of another entity. They can fund recurring maintenance on a specific property or project, prevent assets from going to probate, or allow for gifts to children with more restrictions and safeguards than an UTMA account provides. From a planning standpoint, almost any long-term plan for who should get your money and when can be implemented in a trust
This is not an exhaustive list of account types, and we even skipped some common accounts like 529s and HSAs. The important thing to remember is that when you have new money available to invest, your Advisor can work with you to make sure your money goes into the most appropriate place to achieve your goals, now and in the future.
Note also that the Telarray investment team is able to manage many different accounts under one portfolio structure. If you’re in a 40% bond allocation, each of your accounts won’t necessarily have exactly a 60/40 mix of stock and bond funds. We manage your entire portfolio across all the accounts, which allows us to minimize capital gains, set rules to match appropriate assets to more favorable account types, and minimize trading activity.
Between the formal account types mandated by law and the almost limitless types of trusts that can be established, your money can almost certainly end up where you want it to be for your working life, retirement, and eventual estate—with best practices to receive the most favorable tax treatment along the way.