Traditional cash equivalents like money market funds produce fully taxable income that can shrink significantly after taxes. Alternatives like the BOXX ETF and advisory deferred annuities can offer competitive after-tax returns for investors holding meaningful cash positions.
The Problem with Holding Cash
Most wealthy investors like to hold some cash or cash equivalents such as money market funds or short-term treasuries for safety, liquidity, and future opportunities. Money market funds are currently paying about 3.8% interest. The problem is that most cash equivalents produce fully taxable ordinary income. Depending on your tax bracket and state of residence, that 3.8% can shrink to roughly 2% after taxes.
Fortunately, there are a couple of exceptions.
BOXX: A Tax-Efficient Cash Alternative
One is an ETF called BOXX, a clever play on cash management. The fund seeks to deliver the yield of 1 to 3 month U.S. Treasury bills with far greater tax efficiency by using an option strategy known as a box spread. Unlike money market funds, BOXX does not distribute taxable income along the way. Instead, the return builds inside the share price, and the investor decides when to realize the gain.
How BOXX Compares After Taxes
Hold the ETF longer than a year and the entire gain is taxed at long-term capital gains rates, which can also be offset through direct indexing or tax loss harvesting. A 3.8% return taxed at the maximum 23.8% capital gains rate nets investors about 2.9% after taxes, and often more depending on how long the position was held and whether harvested losses are available to offset the gain.
Advisory Deferred Annuities: A Commission-Free Alternative
Another cash alternative is the advisory deferred annuity. Traditional deferred annuities are sold by insurance agents who receive commissions from the insurance company. To recoup those commissions, insurers place surrender charges on the contracts. So while they may pay about 5% guaranteed, the money is effectively locked up. Advisory annuities are different. They are offered through fiduciary financial advisors who receive no commission from the insurance company, so there are no surrender charges. Investors can earn about 5% guaranteed from highly rated insurance companies, defer all income taxes until withdrawal, and access their funds at any time without surrender penalties.
Why the After-Tax Difference Matters
For investors holding meaningful cash positions, the difference between earning 2% and earning 2.9% or 5% is real money. Before parking cash in a money market fund by default, it pays to consider the alternatives.
Singer Wealth Advisors is a registered investment advisory firm. Discuss with your financial/tax professionals before investing. Investing involves risk. Past performance does not guarantee future results. Material provided for informational purposes only.
FAQ Section
Why do money market funds lose value after taxes?
Money market funds typically generate fully taxable ordinary income, so depending on an investor’s tax bracket and state of residence, a significant portion of the stated yield can be lost to taxes each year.
What is the BOXX ETF?
BOXX is an ETF that seeks to replicate short-term Treasury bill yields using an options-based box spread strategy, allowing gains to build inside the share price rather than being distributed as taxable income annually, with the investor controlling when to realize the gain.
What is an advisory deferred annuity?
An advisory deferred annuity is offered through fee-based fiduciary advisors rather than commissioned insurance agents, which typically means no surrender charges, along with tax-deferred growth until withdrawal.
Are advisory annuities and traditional annuities the same thing?
No. Traditional deferred annuities are usually sold on commission and carry surrender charges to recoup that commission, while advisory annuities are offered without commission through fiduciary advisors, generally allowing more flexible access to funds.
Keith Singer
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