Broadly speaking, investment income falls into several buckets that all receive different tax treatment. For example, qualified dividends generally receive favorable long-term capital gains tax rates. Long-term capital gains from selling investments held longer than one year are also taxed at preferential rates.
Return of capital is generally not immediately taxable, instead reducing your adjusted cost basis and deferring taxes until you eventually sell. Ordinary income, on the other hand, is taxed at your full marginal income tax rate, making it the least tax-efficient form of investment income for most retirees.
Most investors associate ordinary income with bond funds and REITs. However, one of the most popular equity income ETFs falls into that category as well: JPMorgan Equity Premium Income ETF (JEPI). That’s one reason why where you hold the fund can matter almost as much as whether you own it at all.
What Is JEPI and How Does It Generate Income?
JEPI combines two complementary strategies. The majority of the portfolio consists of an actively managed basket of lower-volatility large-cap U.S. stocks selected with the goal of delivering equity-like returns while reducing overall volatility.
The second piece is what generates the income. Roughly 15% of the portfolio is invested in equity-linked notes (ELNs), structured products that replicate the payoff of a one-month out-of-the-money covered call strategy on the S&P 500. This allows JEPI to harvest lucrative option premiums without directly writing index options itself.
The strategy currently costs a reasonable 0.35% expense ratio and, as of the most recent monthly distribution, offers a 9.40% annualized distribution rate. Unlike many high-yield ETFs, JEPI does not use a managed distribution policy. Monthly payouts fluctuate depending largely on market volatility and the premiums generated by its ELNs.
The Tax Difference for JEPI Between a Taxable Account and a Roth IRA
The downside of JEPI’s ELN structure is that much of its distributions are generally taxed as ordinary income. For retirees in higher tax brackets, that can significantly reduce the amount of cash that actually ends up in their pockets.
Assume a retiree owns $200,000 of JEPI. At a 9.40% distribution rate, the position would generate approximately $18,800 per year in distributions. If those distributions are fully taxed as ordinary income, here’s what remains after federal taxes:
| Federal tax bracket | Annual after-tax income |
|---|---|
| 24% | $14,288 |
| 32% | $12,784 |
| 37% | $11,844 |
For someone in the middle 32% bracket, that’s more than $6,000 (or $500 a month) disappearing to federal taxes alone, before considering state income taxes or the 3.8% Net Investment Income Tax (NIIT), where applicable. Now compare that with holding the same $200,000 JEPI position inside a Roth IRA. Assuming qualified Roth withdrawals, the entire $18,800 distribution is tax free.
That’s why account location matters so much. The investment itself hasn’t changed, the yield hasn’t changed, the only difference is where it’s held. Simply moving a tax-inefficient income ETF like JEPI into a Roth IRA can preserve thousands of dollars annually that would otherwise be lost to taxes.
Now, if you’ve already maxed out your Roth IRA and other tax-advantaged accounts but still want income in a taxable brokerage account, it may be worth looking at derivative income ETFs that don’t rely on ELNs. Some funds instead use Section 1256 index options, which receive the more favorable 60/40 long-term and short-term capital gains tax treatment.
Combined with tax-loss harvesting inside the ETF, this accounting approach can allow a substantial portion of distributions to be classified as return of capital, deferring taxes by reducing your adjusted cost basis rather than generating immediate ordinary income.
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