Distributions from Mutual Funds
While mutual fund shareholders can receive capital gain distributions, these gains may actually be disadvantageous to the shareholder. Capital gains and their respective taxes are based on how long the actual fund, not the investor, has held onto a particular security.
Mutual Funds & Capital Gains Distributions
Capital gains distributions are the payments to a shareholder from the profits of the securities’ sale. Many funds allow for an automatic investment of capital gains because capital gains distributions actually reduce the fund’s value. Not only that, but these distributions are fully taxable as well, which reduces the shareholder’s investing potential even further unless the fund is owned in an IRA, 401k, or some other tax-deferred account.
Capital gains distributions are clearly a risky choice at times. At one time mutual funds could receive 20%-30%, resulting in the investors receiving a higher return, even though the taxes would be higher proportionately. Now, however, the rate of return is much lower and thus the overall spending potential is less after these taxes.
Investors whose investments are underwater are most affected by capital gains payments. These investors are essentially picking up the check for shareholders who received all the benefits of the fund but few of the costs. The actual nature of a mutual fund structure is as follows.
A stock holdings’ paper gains could have boosted the fund’s price early in the year. The investor who then sold the fund could cause the fund manager to sell securities in order to cash them out. Later in the year, however, investors who still own the fund, which has lost value since, will still get gains realized last year and thus be in a higher tax bracket.
Lessen Damage of Planned Distributions
To try to bypass these issues, the shareholder must take the initiative. He must contact the fund company or research what the estimated fund’s year-end-distributions will be. Just as importantly, the shareholder must also focus on specifically the fund will be paid. While most fund distributions are less than 10% of the fund’s net asset value per share and thus not substantial, it is important that shareholder know the size of his fund portfolio because the bigger it is, the more tax debt he will accumulate.
Should the shareholder face a substantial distribution, he should sell the fund before the distribution is paid in order to offset any realized gains from his portfolio, be it from individual stocks or other funds. While it does not matter if an investor sells a fund before or after the distribution when taking a loss, the process is simpler in terms of tax paperwork when he does so before the distribution.
If the shareholder find out he has a paper gain on a fund this year, he will have to judge the tax implications of short-term versus long-term gains. Here, it may be beneficial to talk to a financial adviser.
Buyback Rules
If a shareholder sells to capture a loss but wants to buy it back after the distribution due to its long-term prospects, he must wait at least 31 days after a sale or else the capital loss will not be allowed.
For more information about mutual funds and cd rates go to www.cdrates.org
