Account Selector Methodology Document
The Account Selector flow is designed to inform you of accounts that may match your intended use for the account’s funds. You may choose between: Saving for Educational Expenses, Saving for Retirement, Saving for Emergencies, Saving to Build Wealth, Cash Management for day-to-day Spending, Investing & Trading, and Giving to Charity. Flows for Saving for Education and Retirement, which require additional input for account mapping, are described in detail below.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered as legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact the outcome of certain tax planning strategies. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. The Account Selector flows do not provide recommendations and therefore should not be used as the primary basis for any tax-planning decisions or for tax-reporting purposes. You should always consult a tax advisor prior to implementing a specific tax strategy or answering questions specific to your tax situation. Your unique circumstances may not be accounted for in the following decision frameworks.
Decision frameworks are meant to educate you about some of the major differences between multiple account types that could be used for the same purpose but offer varied benefits based on your indicated situation and preferences. Each decision framework prioritizes responses to questions based on a proprietary hierarchy. Each hierarchy generalizes the tax benefit or cost of each step, does not perform quantitative calculations, and does not consider how benefits from subsequent questions may culminate in a benefit greater than a previous step in the hierarchy. The hierarchies are not exhaustive and may not include all considerations that should be made when deciding between multiple account types that could be used. Each decision framework assumes current tax law will remain in place and does not consider your personal tax situation. Contact your tax advisor for help determining how a decision to contribute to the accounts presented within each experience may impact your personal tax situation. If you do not answer all questions and indicate “unsure” when in all questions which it is presented, no evaluation against the Decision Framework will be provided.
Saving for education
This framework will help you decide between a 529 Savings Account and a Custodial UGMA/UTMA (Uniform Gifts to Minors Act/Uniform Transfers to Minors Act) account. Note, there are other account types that can also be used to save for educational expenses. However, the aforementioned account types are most commonly used for the specific purpose of educational savings. The following account features comprise the proprietary hierarchy for Educational Savings:
- Ownership & Control
- Financial Aid
- Use of Funds
Your eligibility to contribute to an UGMA/UTMA is determined by whether you are opening this custodial account for a minor, as you cannot open an UGMA/UTMA for yourself or for another adult. Eligibility is the first indicator in this Decision Framework to determine whether an UGMA/UTMA should be considered. If you cannot open an UGMA/UTMA, the experience will skip the remainder of the questions. By default, a 529 is the resulting account type given your indicated education savings goal.
Ownership and control
Your preference to retain ownership of the account and control over how it’s used and distributed is the second most important factor. For a 529, contributions are considered revocable gifts, with the owner controlling the account and the child as the beneficiary. For UGMA/UTMA, contributions are considered irrevocable gifts (i.e., distributions must be used for the minor), and the custodian controls the account until it is transferred to the minor at the age of majority (differs by state). If the account owner does not want to relinquish control when the account automatically transfers to the child at age of majority to be used in any way the child chooses, a 529 is the resulting account type.
If you indicate that you anticipate applying for financial aid, we consider this the third indicator in the hierarchy, as a 529 account is considered an asset of the owner, not the child (beneficiary), and therefore has a lower weighting in financial aid eligibility formulas, as compared to UGMA/UTMA which is considered an asset of the child and therefore has a higher weighting in financial aid eligibility formulas. Thus, if you indicate that you will likely apply for financial aid, a 529 is the resulting account type.
Use of funds
Your preference to use these funds solely for education vs. allowing the child to use it for anything they wish is the fourth indicator in the hierarchy. For an UGMA/UTMA, assets must be used for the benefit of the child, but can include non-college expenses, and withdrawals can be made at any time, subject to taxes. A 529 may be used for qualified college-related expenses, including tuition, books, etc. $10,000 per year can be applied toward tuition expenses for elementary, middle, and high schools (private, public, or religious). Although the money may come from multiple 529 accounts, it will be aggregated on a per beneficiary basis, and any distribution amount for elementary, middle, and high schools (private, public, or religious) in excess of the $10,000 limit will be subject to income and a 10% federal penalty tax. 529 accounts can be used for fees, books, supplies and equipment for eligible apprenticeship programs. There is also a lifetime limit of $10,000 per individual of student loan repayments. You can withdraw up to the amount of an awarded scholarship without incurring federal penalty tax. You can withdraw money anytime, with any earnings on nonqualified distributions subject to federal income taxes at the recipient’s rate as well as a 10% federal penalty. Note that if your child does not go to college or use it for other qualified education expenses, you will be subject to the 10% penalty on all withdrawals including contributions. Otherwise, all earnings grow tax-deferred in a 529, unlike an UGMA/UTMA in which some of the money is taxed as you go with unearned income potentially subject to the Kiddie Tax. Some in-state 529s may offer state income tax advantages. Therefore, if the primary intended use of funds is for education-related expenses, a 529 account is the resulting account type. If the primary intended use of funds for the minor is non-education-related, then an UGMA/UTMA is the resulting account type.
Saving for retirement
The two account types that this Decision Framework will help you decide between are a traditional IRA and a Roth IRA (individual retirement arrangement). Note, there are other account types that can also be used to save for retirement including taxable brokerage accounts, however the aforementioned account types are the most commonly used individually-owned (i.e., non-workplace, non-employer-sponsored) and tax-advantage accounts for the specific purpose of retirement savings. The following indicators comprise the proprietary hierarchy for Retirement Savings:
- Eligibility to Contribute
- Liquidity pre-retirement
- Withdrawals in retirement
- Tax Benefits
- Tax Savings Today vs. In Retirement
Eligibility to contribute
Your eligibility to contribute to either or both IRAs is determined by your inputs and IRS calculations. Eligibility is the first indicator in the hierarchy for determining which IRA may be appropriate. As traditional IRAs do not have income phase outs for contributions, if your provided MAGI surpasses the Roth IRA contribution limits, a traditional IRA is the resulting account type. If your income surpasses the traditional IRA income phase out for deducting your IRA contributions, but is below the Roth IRA contribution limits, the Roth IRA is the resulting account type.
Your preference to withdraw assets prior to age 59.5 is the second indicator in the hierarchy. Distributions can result in significant taxes and penalties. Roth IRAs allow for tax-free and penalty-free withdrawals of contributions at any point while early withdrawals from traditional IRAs may be subject to taxes and incur a 10% penalty. In most cases, these penalties can outweigh the potential tax benefits of tax arbitrage (discussed below). If you indicate you plan to take withdrawals prior to age 59.5, the Roth IRA is the resulting account type.
Your preference to keep assets in the account past the age of 73 is the third indicators in the hierarchy. Traditional IRAs have RMDs that will require you to take a growing percentage of your assets out of the account over a period of time. For some individuals, this may result in an increase in tax liability. If you plan to withdraw the assets anyway, this may be unavoidable. However, if you intend to keep assets in the account beyond the age of 73, a Roth IRA can help you avoid these required withdrawals and any resulting taxes. If you indicate you plan to keep assets invested past the age of 73, the Roth IRA is the resulting account type.
Your expectation for your future income is the fourth indicator in the hierarchy. Here the experience considers the benefit of tax arbitrage: paying taxes when your tax rate is lower vs. when your tax rate is higher. If you indicate your expected tax rate will decrease in retirement, the traditional IRA is the resulting account type.
Tax savings today vs. retirement
Your preference to save more on taxes today than in retirement is the fifth indicator in the hierarchy. Potential tax deductions received by contributing to a traditional IRA may provide more flexibility ahead of retirement than tax savings received at the time of withdrawal in retirement from a Roth IRA even if there is no difference in tax benefit. Flexibility may not always be desired, and a Roth IRA can help reduce the temptation to spend a current year’s tax savings on non-retirement goals by locking away tax savings until retirement. If you indicate you prefer tax savings today, the traditional IRA is the resulting account type.
Assumptions and Limitations
This experience assumes your reported income is equivalent to your MAGI (Modified Adjusted Gross Income). This may not be the case for your personal situation. Income may be higher or lower than your AGI (Adjusted Gross Income) and further adjusted when determining MAGI for potential traditional IRA tax deductible contributions and Roth IRA contribution limits.
Only total phaseouts are considered by the experience. Partial phaseouts of the amount you can contribute to an IRA, either through tax-deductible contributions to traditional IRAs or non-deductible contributions to Roth IRAs, are not considered by the experience. Non-deductible contributions to a traditional IRA do not have phaseouts. To contribute to either IRA, you must have taxable compensation equal to or greater than the contribution amount and aggregate contributions must be below the annual IRS limit.
If married filing separately, the experience assumes you lived with your spouse at some point during the year. If you did not live with your spouse during the year, the results from this experience may not accurately reflect your situation.
The Roth IRA allows for tax and penalty-free withdrawals from contributions at any time if certain conditions are present. The experience does not consider other instances when an early withdrawal may be beneficial from a Roth IRA over a traditional IRA such as withdrawals from earnings at least 5 years following account opening and covered by an exemption such as death, disability, or first-time home purchase (up to $10,000) among others. Additionally, the experience does not consider penalties or taxes that may be applicable on withdrawals from converted balances within the first 5 years from the conversion.
When determining which account may result in tax benefits based on a change in expected future tax rate, this experience assumes that any tax savings received will be reinvested in a taxable account and subject to taxation at the preferred long-term capital gains rate upon withdrawal. Any indicated reduction in future tax rate is assumed to be large enough such that the tax arbitrage from a tax-deductible contribution to a traditional IRA followed by a withdrawal in retirement results in net tax savings compared to a similar contribution and withdrawal from a Roth IRA.
Tax year is always assumed to be the earliest year available for IRA contributions. Around the federal tax filing deadline, the tax year is switched to the next tax year. If you have already maximized IRA contributions for the current or prior tax year, if before the tax filing deadline in the following year, this experience may not be right for you.
Results from responses to each indicator may be ambiguous. Ambiguous results on one of the indicators causes that indicator to be skipped in the hierarchy. If there are sufficient ambiguous results, both IRAs may be presented as an option available and a single resulting account type is not indicated.