A retiree wants income, low cost, and tax efficiency. You can reach for an open-end bond fund, a closed-end fund trading at a discount, an ETF, or a variable annuity. Each wrapper holds similar securities but prices, charges, and taxes them differently. Knowing the wrapper is half the exam.
Every recommendation starts with the profile: age, time horizon, income needs, risk tolerance, tax status, and existing holdings. The product must fit the profile, not the other way around. A money market fund suits a parking place for cash. An equity growth fund suits a long horizon. A variable annuity suits tax-deferred retirement savings for someone who has already maxed other tax-advantaged accounts. Recommending a high-cost share class or a long-surrender annuity to a short-horizon client fails the suitability standard.
A packaged product is only as good as what it holds. Know the building blocks.
Money market funds hold the short-term instruments at the bottom: commercial paper, brokered CDs, bankers' acceptances, and T-bills. These are low risk, high liquidity, short maturity.
Common mistakes
- Pricing open-end funds at the market. Open-end shares price at NAV forward, not on an exchange. Only closed-end funds trade at a market price that can sit at a premium or discount to NAV.
- Forgetting the 90% distribution test. Conduit treatment requires distributing at least 90% of net investment income. The fund pays tax on whatever it retains.
- Mis-sizing the wash sale window. It is 61 days total: 30 before, the sale day, and 30 after. A repurchase on day 30 still disallows the loss.
Bottom line
- Conduit (pipeline) theory lets a fund avoid tax on distributed income if it pays out at least 90% of net investment income; the investor is taxed, not the fund
- Open-end funds price forward at NAV next computed; offering price = NAV + sales charge; closed-end funds trade in the secondary market at a market price that can differ from NAV
- Maximum mutual fund sales charge is 8.5% under FINRA Rule 2341; breakpoints, letters of intent, and rights of accumulation reduce it
- 12b-1 fees pay for distribution and marketing; a fund cannot call itself no-load if its 12b-1 fee exceeds 0.25%
Exam shortcut
Open-end equals NAV, closed-end equals market. If the question says shares trade at a premium or discount, it is a closed-end fund. If it says next computed price, it is open-end forward pricing. Annuity gains are ordinary, LIFO, plus 10% before 59½. Whenever a variable annuity withdrawal appears, reach for ordinary income and the penalty, never capital gains or step-up. Wash sale is 30 days each side.
The full lesson (about 2,956 words, 20 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C8
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