Taxes and Private Wealth Management Flashcards
Tax Deferred Account
Defers taxation on investment returns within the account
may permit deduction on contributions
may ocassionaly permit tax free distributions
Accrual Tax
Paid periodically.
After Tax returns = r(1-t)
Deferred Tax
Postponed till a future date
FVIF = (1+r)^n -[(1+r)^n-1]*t(cg)
Future Value Interest Factor
Tax Drag
The money accumulated after paying tax each year and re-investment
FVIF = [“FVIFi =⎡⎣1+r(1−ti) ] ^n
Negative effect of taxes on after tax returns
Impact of Accrual Taxes on Capital Growth
- The effect of tax is greater than nominal rates
- Increased effect as time horizon of the investment increased
- Tax drag increases and the investment return increased
- The time horizon and return rate increase has a multiplicative effect on future accumulations.
Impact of Deferred Taxes on Capital Growth
Comparison with accrual tax
- Tax drag fixed percentage (Same as the nominal rate)
- More effecient than accrual tax if both rates are equal
- However, the tax benefit will be lower if the returns from accrual taxes securties have greater risk adjusted returns
- Countries gain in two ways : lesser capital gains tax and deferral tax benefit.
Cost Basis
Amount paid to acquire the asset
Difference between SP-CB is the taxable gain.
As cost basis decreases, taxable gain increases.
There is an embeded tax liability if the cost basis in lower than the current market value
“FVIFcgb =(1+r) 1−tcg +tcg −(1−B)tcg”
B is expressed as a percentage of current market value
Wealth Based Tax
Impact
Applied to specific capital base. The principal and return both are taxed. Hence the accumulation is different than returns based tax
FVIF = [(1+r)(1-t)]^n
Increases in investment horizon increases
Less sensitive to investment return As investment return increases the proportion of investment growth consumed by tax decreased
