This hypothetical example is not intended to predict or project investment results. Your actual results may be higher or lower than those shown here.
Assumptions include: $250,000 investment, 20-year time horizon, 0.25 percent annual annuity charge for the tax-deferred variable annuity (VA), marginal federal income tax rate of 36.8 percent (33 percent ordinary income tax plus 3.8 percent Medicare surtax) for the entire period, and a 6 percent annual rate of return (equivalent to a 5.74 percent net annual rate of return for the VA) with the gain assumed to derive entirely from income (characterized for tax purposes as ordinary income). Investments that have the potential for a 6 percent annual rate of return also come with the risk of loss. This rate of return is not guaranteed.5
The bottom line
There is a lot of complexity in the financial world, but some of the most important habits of successful investors are pretty simple. If you build a smart plan and stick with it, save enough, make reasonable investment choices, and beware of taxes, you will have adopted some of the key traits that may lead to investing success.
Find helpful guidance, tools, and services to assist you as you prepare for retirement on your terms. See more Fidelity Retirement Viewpoints.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
1 Data for the Fidelity Investments Retirement Savings Assessment were collected during August 2015 through a national online survey of 4,650 working households earning at least $20,000 annually, with respondents age 25 to 75. All respondents expect to retire at some point and have already started saving for retirement. Data collection was completed by GfK Public Affairs and Corporate Communication using GfK's KnowledgePanel®, a nationally representative online panel. The responses were benchmarked and weighted against the 2014 Current Population Survey by the Bureau of Labor Statistics. GfK Public Affairs and Corporate Communication is an independent research firm not affiliated with Fidelity Investments. Fidelity Investments was not identified as the survey sponsor.
2 All data based on Fidelity analysis of 22,000 corporate defined contribution plans (including advisor-sold DC) and 13.6 million participants as of December 31, 2015. Performance statistics for continuous participants from the fourth quarter or 2008 to the fourth quarter of 2015. Roughly 1.5% of participants went to 0% equities during the fourth quarter of 2008 or first quarter of 2009.
3 Source: Fidelity Investments, "The Challenge of Identifying—and Adhering to—an Appropriate Level of Portfolio Risk," June 2016.
4 Calculation assumes $100,000 investment made on Dec. 31, 1995, and compounded yearly until Dec. 31, 2015, using actual S&P 500® yearly returns plus 0.18 percentage points or minus 0.71 percentage points (representing the average filtered active fund and average active fund, respectively), or returns minus 0.04 percentage points or minus 0.36 percentage points (representing the average filtered index fund and average index fund, respectively). S&P 500 returns assume all dividends are reinvested. See below for filter methodologies.
5 In the taxable account, it is assumed that taxes incurred on the income are paid annually from the income itself, with the remainder reinvested. In the tax-deferred account, it is assumed that all income is reinvested. For the VA, it is assumed that all income — less the 0.25 percent annual annuity charge, billed quarterly — is reinvested. It is assumed that the investor liquidates the VA and the tax-deferred account at the end of the time period, and pays taxes on the gains out of the proceeds. If the assets in these accounts were liquidated entirely in one year, the proceeds might increase the tax bracket to the marginal federal income tax rate of 43.4 percent (39.6 percent ordinary income tax plus 3.8 percent Medicare surtax), which would minimize and potentially eliminate any savings. To avoid this, the VA and tax-deferred account would need to be liquidated over the course of several years or annuitized, which would lengthen the deferral period. State and local taxes, inflation, and fund and transaction fees were not taken into account in this example; if they had been, performance for the taxable account, the variable annuity, and the tax-deferred account would be lower. This example also does not take into account capital loss carry-forwards or other tax strategies that could be used to reduce taxes that could be incurred in a taxable account; to the extent these strategies apply to your situation, the comparative advantage of the variable annuity and tax-deferred account would be diminished. Lower tax rates on interest income would make the taxable investment more favorable. Changes in tax rates and tax treatment of investment earnings may affect the comparative results. Consider your current and anticipated investment horizon and income tax bracket when making an investment decision, as the illustration may not reflect these factors.
Ordinary income tax rates will apply to taxable amounts withdrawn from a tax-deferred investment.
The year-by-year account value for the taxable account shown above is: $259,480 for year 1, $269,319 for year 2, $279,532 for year 3, $290,132 for year 4, $301,134 for year 5, $312,553 for year 6, $324,405 for year 7, $336,706 for year 8, $349,474 for year 9, $362,726 for year 10, $376,481 for year 11, $390,757 for year 12, $405,574 for year 13, $420,954 for year 14, $436,916 for year 15, $453,484 for year 16, $470,680 for year 17, $488,528 for year 18, $507,053 for year 19, and $526,281 in year 20. The year-by-year value values after federal income taxes have been deducted for the VA with 6% return less the 0.25% annual annuity charge shown above is: $259,061 for year 1, $268,642 for year 2, $278,773 for year 3, $289,484 for year 4, $300,810 for year 5, $312,785 for year 6, $325,447 for year 7, $338,835 for year 8, $352,991 for year 9, $367,959 for year 10, $383,785 for year 11, $400,519 for year 12, $418,213 for year 13, $436,921 for year 14, $456,702 for year 15, $477,618 for year 16, $499,733 for year 17, $523,117 for year 18, $547,841 for year 19, and $573,984 in year 20. The year-by-year value for the VA at a 0% annual return less the 0.25% annual annuity charge is: $249,375 for year 1, $248,752 for year 2, $248,130 for year 3, $247,509 for year 4, $246,891 for year 5, $246,273 for year 6, $245,658 for year 7, $245,044 for year 8, $244,431 for year 9, $243,820 for year 10, $243,210 for year 11, $242,602 for year 12, $241,996 for year 13, $241,391 for year 14, $240,787 for year 15, $240,185 for year 16, $239,585 for year 17, $238,986 for year 18, $238,388 for year 19, and $237,792 for year 20.
Withdrawals of taxable amounts from tax-deferred IRAs and annuities are subject to ordinary income tax rates, and, if taken before age 59½, may be subject to a 10 percent IRS penalty.
VAs are generally not suitable for investors with time horizons of less than 10 years, as in most cases there is little to no advantage over a taxable account for the first 10 years of the investment. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
In general, the bond market is volatile, and fixed-income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed-income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.
Changes in real estate values or economic conditions can have a significant positive or negative effect on issuers in the real estate industry, which may affect your investment.
It is not possible to invest directly in an index. All indexes are unmanaged.
The S&P 500 Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
The Dow Jones Wilshire 5000 is a market capitalization-weighted index of approximately 7,000 stocks.
The Barclays Capital Global Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar denominated.
MSCI EAFE (Europe, Australasia, Far East) Index is a market capitalization-weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the U.S. and Canada. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the Stocks, Bonds, and Inflation (SBBI) 2001.
Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield). Domestic stocks are represented by the S&P 500® Index, bonds are represented by U.S. intermediate-term government bonds, and short-term assets are based on the 30-day U.S. Treasury bill. Foreign equities are represented by the Morgan Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign equities prior to 1970 are represented by the S&P 500® Index.
About the active-passive data in this story.
Fund selection: Our main analysis focused on all U.S. large-cap mutual funds tracked by Morningstar between Jan. 1, 1992, and Dec. 31, 2015, including all blend, value, and growth funds and including actively managed and passive index funds. We included funds that did not exist for the entire period (closed or merged funds), to reduce survivorship bias. We eliminated funds identified as passive that were labeled as "enhanced index," and eliminated funds with tracking error greater than 1% (which are unlikely to be actual passive index strategies despite their identification in the database). See below for benchmark indexes included and definitions.
Our analysis began with the entire set of funds with available data from Morningstar at any point over the full period: 2,013 actively managed mutual funds, and 115 passive index mutual funds. We selected the oldest share class for each fund as representative; where more than one share class was the oldest available, we chose the class labeled as "retail."
For U.S. large-cap equity, average fund counts for each subset of selected funds are as follows: Unfiltered (full set of funds available): active 831, passive 50. Fee filter only: active 220, passive 13. Size filter only: active 79, passive 5. Both filters applied: active 46, passive 3.
Averaging excess returns: We used Morningstar data on returns from Jan. 1, 1992, through Dec. 31, 2015. We calculated each fund's excess returns on a one-year rolling basis, relative to each fund's primary prospectus benchmark and net of reported expense ratio, for each month. We used an equal-weighted average to calculate overall industry one-year returns for each month. (We chose equal weighting for the averages in order to represent the average performance of the range of individual funds available to investors, rather than asset weighting, which may introduce bias into an analysis.) For filtered subsets of funds, average excess returns ascribed were the one-year forward rolling returns, calculated monthly. All filtered subsets were rebalanced monthly. If a fund closed or was merged during a one-year rolling period, its returns were recorded for the months that it was in existence, and the weighting of the remaining funds in the subset was increased proportionally for the remainder of the year.
For a more detailed description of this methodology, see Fidelity Leadership Series article "U.S. Large-Cap Equity: Can Simple Filters Help Investors Find Better-Performing Actively Managed Funds?" (May 2015).
Indexes: Funds in the study included active and passive funds tracked by Morningstar and benchmarked to the following indexes: U.S. large-cap equity (all in USD): Russell 1000; Russell 1000 Growth; Russell 1000 Value; Russell 3000; Russell 3000 Growth; Russell 3000 Value; S&P 500.
Before investing in any mutual fund, consider the investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk.
Investments in smaller companies may involve greater risks than those in larger, more well-known companies.
Active and passively managed funds are subject to fees and expenses that do not apply to indexes. Indexes are unmanaged. It is not possible to invest directly in an index.
Excess return: the amount by which a portfolio's performance exceeds its benchmark, net (in the case of the analysis in this article) or gross of operating expenses, in percentage points.
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