At the end of this year, many mutual funds are expected to
distribute sizeable capital gains to shareholders who will have to pay taxes on
them. That is true of stock mutual funds that sold off last week after carrying
forward big gains from 2013, and also may be true of the popular Pimco Total
Return Fund.
Here is why:
Mutual funds must distribute realized gains to their shareholders every
calendar year. Managers of both bond and stock funds have seen sizeable gains
for several years running, but have not had to sell shares and realize those
gains. This year, there have been some big selloffs that may have forced the
managers to sell winning securities and realize those gains for tax purposes.
For individual investors, those gains might hurt more than
they would have over the last few years, because a lot of investors have been
offsetting their taxable gains for years with losses they carried over from the
2008-2009 rout. Now, with most of their losses used up, they will have full
exposure to the gains. Long-term gains are typically taxed at 15 percent; those
in the top tax bracket face a capital gains tax rate of 20 percent.
Stock fund investors could be harder-hit, said Morningstar
analyst Russel Kinnel. He estimates that U.S. domestic stock funds might be
sitting on gains of around 20 percent and could end up paying 16 or 17 percent
of their value to shareholders as gains.
Note that none of this affects investors who hold mutual
funds through tax-favored retirement accounts. They do not have to pay annual
taxes on fund earnings. For everyone else, there are very few ways to
minimize the impact of those taxable gains. Here are some strategies that might
help.
- If you bought
recently, you might consider selling quickly. If you have not seen much of
a gain in a fund you bought, or if you have actually sustained a loss, you can
sell shares and either use your capital loss to offset other gains, or at least
get out before the gain is distributed. That strategy will not work if you have
been in the fund long enough to rack up your own gains - then you will just
have to pay taxes on them when you sell.
- Think before you
buy. The people who will get hardest-hit by these year-end mutual fund
taxes are people who have not owned the funds for long. They buy in just before
the distribution, miss out on the actual gains, but get hit with the taxable
distribution anyway. Do not buy any funds this year until you have checked with
the fund company to find out when it is distributing 2014 gains. If you think
it is a fund that is sitting on big gains, wait until that date passes before
making your purchase.
- Take losses. If
you own any stocks or funds that have lost money since you have held
them, sell and reap the loss. It can offset those fund gains.
- Relax. At 15
percent for most people (20 percent for top tax bracketeers), the capital gains
tax is still much lower than regular income taxes. And there are worse things
than having to pay taxes because you made money.
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