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Author: GrayWulff Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75824  
Subject: Re: 403(B) or Non-Retirement Mutual Fund?? Date: 10/27/1999 9:33 PM
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You need to rethink your figures that you're using. If one in investing something that can produce 12% rate of return (apparently equities), one is not going to be taxed at their marginal tax rate as all the earning is not taxable . . . nor might it be all ordinary income taxable . .. right?

TTRoberts,

Thanks for the question. The table is pretty dense with information, and maybe I did get it wrong, but I did apply the capital gains rate of 20% to the taxable portfolio. And even that was only applied to the gains, using the average cost method. It might be possible to delay the taxes a bit by using a different method.

It was the tax deferred portfolio where I used the marginal tax rate of 28%. It's my understanding that that is how Traditional IRA's and 401k's work. I don't know about 403b's.

. . . . They found that in mutual fund taxes shaved from 1.5% to a little over 3 percentage points off the return. So, to account for taxes, you might was to shave 2 points off and use 10% instead of 12% for comparison.

Another good point. That would certainly be true of most actively managed mutual funds, but not of a low turnover index fund like VFINX. (VFINX is indeed the equities investment I had in mind.)

VFINX has been running only 5 to 6% turnover for many years. Last year 6% turnover produced only 1% capital gains distribution. Also, any taxable gains distributions would then be balanced by a rise in the cost basis with resulting reductions in taxes later. Too much complication for a quicky spreadsheet. Anyway, it could only make the taxable portfolio look worse, it wouldn't apply to the tax deferred portfolio. So, it wouldn't affect the conclusion.

I haven't tried different rates of gain, but my intuition says that the higher the average pre-tax gain, the more favorable the taxable portfolio will look. But that's just a guess; I'll plug some number tomorrow and post the results.

The biggest drivers are certainly the marginal tax rate on ordinary income, and the long term capital gains tax rates.

Cheers,
GW
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