By Stan Choe
AP Business Writer
NEW YORK (AP) - Tax time means many mutual-fund investors are paying the bill for their funds' past successes, even ones that predate their own investment.
Anyone with a fund in a taxable account is now sitting down with their 1099 forms, or will be by April 18. That's because funds paid out capital-gains distributions to their shareholders in December, and investors with a fund outside a 401(k) or another tax-advantaged account are liable for taxes on them, even if they didn't sell any shares.
The good news is that 2016 capital-gains tax bills are smaller for many of the most popular actively managed mutual funds than they were in 2015. And index funds and ETFs, which have become the investment of choice for more and more savers, continue to be tax-friendly with either no or small gains distributions.
It's encouraging for investors, particularly when strategists along Wall Street are forecasting weaker upcoming returns because of already high prices for stocks and bonds. If investment returns are low, it becomes even more important to hold onto more of them by keeping taxes and expenses low.
Capital-gains tax bills stem from the gains that funds book from buying and selling stocks, bonds and other investments. At the end of each year, funds tally up their total gains and then pass them on to shareholders. The distributions go to anyone in the fund as of a certain date, regardless of when they entered.
Consider the American Funds Growth Fund of America, one of the largest mutual funds with $155.5 billion in assets.
It sent shareholders a capital-gains distribution in December of $2.53 per share, which was close to 6 percent of the fund's total net asset value. At the same time, the fund's share price dropped by the same amount.
So, someone with $10,000 invested in the fund would still have $10,000, but $593.29 would be in the form of a taxable capital-gains distribution, one that could be re-invested in the fund. For high-income investors, that could mean a tax bill of up to $141.20 at the top long-term, capital-gains tax rate of 23.8 percent.
But that's down from 2015, when the fund made a distribution of $3.39 per share, or 8 percent of its net asset value. For someone with $10,000 invested in the fund at the time, that could have meant a tax bill of up to $196.27 for high-income investors.
The story is similar across many of the largest mutual funds. Fidelity's Contrafund paid $3.46 per share in total capital-gains distributions last year, down from $4.96 in 2015, for example. The T. Rowe Price Growth Stock fund paid a gains distribution of $1.14 per share, down from $3.88.
Here are some guidelines experts suggest to keep in mind when it comes to taxes:
- Make sure you're taking advantage of your tax-advantaged accounts.
Investors don't need to worry at all about capital-gains distributions made by funds held in a 401(k), Individual Retirement Account or another tax-deferred account. That's why some investors make sure to keep their actively managed funds, bond funds and other fund investments that can create bigger tax bills sheltered in such accounts, while holding their more tax-efficient options in their taxable accounts.
Keep in mind that tax-advantaged accounts tend to restrict access to the money until retirement age. So don't stick investments into a tax-advantage account just to avoid taxes if you're planning on cashing it out soon.
- Consider index funds and ETFs.
Actively managed funds tend to have bigger distributions than index funds simply because they buy and sell holdings more often. Many big actively managed funds tend to hold stocks for a few years before selling, if that, which means they're replacing about a quarter to a third of their portfolios annually.
Some funds have a turnover rate of 100 percent or more, which means they're replacing everything in their portfolio annually. That can mean more of their distributions are subject to higher short-term capital gains taxes.
Index funds, meanwhile, buy and sell only to keep pace with the indexes they're trying to track. The biggest mutual fund by assets, Vanguard's Total Stock Market Index fund, turned over just 4 percent of its portfolio last year.
- Consider tax-managed funds.
The trend in recent years has been toward index funds and away from actively managed ones, but some market watchers say conditions are improving for stock pickers. Because the Federal Reserve is pulling back from its Great Recession-era moves to prop up markets, analysts are expecting stocks to move less in sync with each other. That should help stock pickers reap bigger rewards for identifying winners and avoiding losers.
Some actively managed funds try to limit the tax bills that come with active management. Funds that go by the "tax-managed" label try to trade less often and may also avoid stocks that pay dividends, whose income is taxable.
Published: Wed, Mar 08, 2017
