New tax law changes as part of the fiscal cliff deal could have a negative impact on portfolio returns in 2013 and beyond, according to Fidelity Investments.
The Fidelity Investments 2013 guide to taxes and Get real: focus on real after tax-returns tackle the question about what to do with higher tax rates and help retirees understand why they may want to adopt a strategy focused on real after-tax returns and not just total return.
"Investors focused solely on what the market is doing for their portfolios are only seeing half the picture," said John Sweeney, executive vice president at Fidelity. "It's the returns they can generate after inflation and taxes that tell the whole story. Fidelity is encouraging investors to sharpen their focus on real after-tax returns, which is what remains after taxes and inflation are accounted for, and not just on nominal pre-tax returns—also referred to as total returns."
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The majority of investors are concerned about taxes, according to a recent Fidelity investor poll. Taxes and inflation both eat away at an investor's portfolio, which puts retirees living off their assets at particular risk. The worst-case scenario is that rising inflation and taxes could force retirees to increase their withdrawals to maintain their lifestyle, which could cause them to run out of money prematurely.
For some high-income earners, tax rates are going up. For others, the biggest change may be a new level of certainty around the tax code.
"Now that many of the expiring tax cuts and temporary tax relief provisions have been made permanent, investors have the opportunity to take stock of the situation, create a careful plan, and then put it into practice over the coming years," said Sweeney.
While taxes have been top-of-mind for many investors, decades of moderate inflation may have made many complacent about risk that it can pose to their portfolios. History contains several examples of time periods when both inflation and tax rates were on the rise, and the challenge that dynamic can pose for investors.
Two potential strategies designed to help alleviate these concerns include the use of "real return" investments that aim to outpace inflation, and Roth retirement savings accounts, which are funded with after-tax money but offer tax-free earnings, provided certain conditions are met, according to Fidelity.
Fidelity Investments is one of the world's largest providers of financial services, with assets under administration of $4.0 trillion, including managed assets of $1.7 trillion, as of Jan. 31, 2013.
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