Taxes on mutual fund distributions

A Year-End Surprise: A Tax Bill on Top of Your Mutual-Fund Losses

Investors need to decide soon how to handle capital-gains distributions from their mutual funds. ‘It’s like getting hit when you’re down,’ says one retiree.

By Laura Saunders, The Wall Street Journal, Dec. 9, 2022

This is happening because fund managers have had to sell holdings to raise cash to pay investors leaving their funds. That often triggers payouts of taxable capital gains for investors who remain…

Here’s what’s behind the large payouts: By law, mutual-fund managers can sell holdings that have declined in value and save up capital losses to offset future capital gains on holdings that have risen in value. However, each year they must send current investors almost all net capital gains that aren’t offset by losses.

After years of strong markets, many managers had few losses this year to offset gains on sales of winners. So when fundholders sold as markets tumbled, the managers often had to sell winners to meet redemptions—and the capital gains on the sales were then spread among remaining fundholders. … [end quote]

This only affects taxable accounts, not IRAs. Better candidates for taxable accounts are passive investments in equities such as exchange-traded funds and index funds that seldom have large payouts.

I once made the mistake of buying into a mutual fund in November, only to be surprised by a taxable capital gain on a distribution in December. That’s how I learned the hard way to check the distribution date before buying a fund. That was before ETFs were offered.

Wendy

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Thanks for this reminder. I just checked the estimated distribution for 2 long held mutual funds in my taxable account.

Together, the estimated distribution will be $15k. My long term cap gains on the funds are only $20k. I’m thinking that i should sell prior to the distribution date. I will have to pay tax on the 20k but that is only on 5k more than i would have to pay anyway. If i want, I can re-purchase the funds after the distribution date to reset the cost basis.

Digging a little deeper i see that these mutual funds (Vanguard) are closed to new investors so if i want to reinvest i would need to keep a token amount when selling. If i understand this correctly, the distribution will be based only on the shares held on the distribution date.

Does the above sound like a reasonable plan. Any gotchas that i am missing?

Thanks.
trs

@bclstube please see the post I just wrote about “wrapper swapping.” You might want to consider selling the mutual fund and buying a similar ETF which would be more tax-efficient.
Wendy

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Thanks, I am considering this, although the 2 funds are actively managed, have a good long-term track record and i have not found a corresponding etf.

And, for a silly sentimental reason, the Vanguard Primecap fund was the first investment I ever made, more than 35 years ago.

Still, the tax ramifications of mutual funds may not be worth it.

Thanks,
trs