Advertisement
retirement

Hefty Fund Payouts Trigger Big Tax Hit

Investors have been socked with sizable taxable distributions in recent years, and 2018 will be no different.

This can be a taxing time of year for mutual fund investors. Toward the end of each year, mutual funds generally distribute to shareholders their net capital gains, or profits on the sale of fund holdings. If you hold funds in a taxable account, you will owe tax on those distributions—even if you reinvest them back in the fund. And if you buy into a fund just before a distribution, you will owe tax on gains you didn’t even receive.

Advertisement - Article continues below

Many funds have socked investors with sizable taxable distributions in recent years—and this year is likely to bring more of the same, fund analysts say. Two factors are supersizing the payouts. Thanks to years of strong stock market performance, many fund portfolios are full of appreciated holdings. What’s more, as the popularity of index-tracking funds soars, investors have been yanking money from actively managed funds. That can force fund managers to sell holdings to raise cash to meet investor redemptions, realizing gains that they must distribute to shareholders. Even worse, those gains are distributed over a smaller number of shareholders, increasing the tax pain for each investor remaining in the fund.

Fund payouts have soared in recent years as stocks marched higher. Mutual funds distributed $370 billion in capital gains to shareholders in 2017, up from $220 billion in 2016 and just $15 billion in 2009—the year stocks hit their financial-crisis nadir. Nearly half of 2017 distributions were paid to taxable household accounts, according to the Investment Company Institute, a fund-industry trade group. (If you hold funds in an IRA or other tax-advantaged account, the distributions don’t affect you.)

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

The gravity of a big capital-gains distribution depends in part on your tax bracket. In 2018, singles with income up to $38,600 and married couples filing jointly with income up to $77,200 don’t need to sweat it: Their capital-gains tax rate is 0%. Taxpayers with higher income, however, pay 15% or 20%.

Check fund-company websites now to find the date and estimated amount of year-end distributions. The estimates are often listed as a percentage of the fund’s current share price. A distribution amounting to 2% or 3% of the fund share price may not be worth getting excited about. A 20% or 30% distribution, however, is more painful—and could be a reminder to reassess the types of investments you hold in taxable accounts.

Dealing With a Hefty Payout From a Fund

Some funds have already announced that big distributions are coming at the end of this year. The Harbor International Fund, for example, said that it will make a mid December distribution of $21.50 to $23.50 per share, or 34% to 37% of the fund’s share price as of early October. That’s partly the result of a recent management change at the fund: The new managers sold off many holdings in order to shift the portfolio to their desired investments, Harbor said.

Advertisement - Article continues below

If you hold a fund that’s about to make a big payout, avoid investing additional money just before the distribution. You’d be taking a tax hit for gains that happened before your investment, says Jeff Tjornehoj, director of fund insights at financial-technology firm Broadridge.

Look to harvest losses elsewhere in your portfolio to offset the gain. “We go actively looking in those last two to three months of the year to take losses where possible,” says Lou Stanasolovich, chief executive officer of Legend Financial Advisors, in Pittsburgh. “But there aren’t many of them these days.”

Don’t rush to dump a fund just to avoid the distribution. If you’re a longtime shareholder, your cost basis in the fund may be well below your sale price—and the tax bill on that gain could be much bigger than the distribution tax bill you dodged. But if you were planning to sell the fund anyway—or trim your allocation because you’re rebalancing your portfolio—it may make sense to pull the trigger before the payout.

Longer term, tax-sensitive investors should consider keeping actively managed stock funds in tax-deferred accounts, Tjornehoj says. Reserve taxable accounts for index funds, exchange-traded funds and other more tax-efficient vehicles.

Advertisement
Advertisement

Most Popular

11 Dividend-Paying Stocks You Should Think Twice About
dividend stocks

11 Dividend-Paying Stocks You Should Think Twice About

Dividend-paying stocks often can be a store of safety, but 2020 has been difficult on income equities. These 11 picks look like shaky plays despite th…
September 21, 2020
Medicare Basics: 11 Things You Need to Know
Medicare

Medicare Basics: 11 Things You Need to Know

There's Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare --…
September 16, 2020
Where You Should Invest Now
investing

Where You Should Invest Now

Kiplinger.com senior investing editor Kyle Woodley joins our Your Money's Worth podcast to answer investor questions about tech stocks, the election a…
September 22, 2020

Recommended

The Annuity With a Tax-Planning Twist
Financial Planning

The Annuity With a Tax-Planning Twist

A qualified life annuity contract helps retirees with guaranteed payments to last their entire lives.
September 21, 2020
HSA Limits and Minimums
health savings accounts

HSA Limits and Minimums

Annually adjusted contribution limits and other requirements must be met if you're covering health care costs with a Health Savings Account.
September 21, 2020
Don’t Be Paralyzed by Uncertainty
retirement planning

Don’t Be Paralyzed by Uncertainty

You definitely need a plan, because what’s ahead could be scarier than what’s behind us.
September 21, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020