As your year-end mutual fund statements and tax documents arrive you should make sure that you take a close look at the performance of your funds AND whether you have a sizeable capital gains distribution. Often the fourth quarter is when mutual fund companies inform their investors of capital gains distributions. Investors will have to pay capital gains taxes on these distributions regardless of whether they have sold their fund holdings or not (unless your income is below $38,600 for individuals and $77,200 for married tax filers where the cap gains tax rate is 0%). Furthermore, depending on when you invested in a fund, your
performance may show that you are losing money on the investment but still owe capital gains tax.
These distributions are caused by capital gains that the mutual fund has from selling appreciated stocks over the year as well as dividends and interest from investments. Some reasons why the fund would sell are: 1) a change in a fund’s portfolio manager could result in a major shakeup in the holdings of the fund to align with the new manager’s views; 2) redemptions which result in the fund having to sell stocks to raise money; 3) market volatility could cause a portfolio manager to reduce equity positions.
Capital gains distributions of 2-3% are not a big deal, however, a 20-30% distribution is more painful. Capgainsvalet.com publishes a list of funds that have 20%+ capital gains distributions in 2018 ( CLICK HERE TO SEE THE CURRENT LIST ).
Some advice regarding how to handle capital gains distributions:
- Avoid investing in a mutual fund that is about to make a big payout. You’d be taking a tax hit for gains that happened before your investment
- Look to harvest losses elsewhere to offset those gains
- Long-term, tax-sensitive investors should consider keeping actively managed mutual funds in tax-deferred accounts
- Don’t rush to liquidate a long-term fund holding just to avoid the distribution, your tax hit may be higher than what it would have been from the distribution
At Chatham Wealth Management, we manage our client portfolios tax efficiently, looking to offset realized gains with any unrealized losses as we approach the end of the year (commonly referred to as tax loss harvesting). We invest in individual stocks and bonds which allows us to help manage our client’s tax obligation. We offer a complimentary portfolio review and can also give our thoughts on your fund holdings. Please contact us at (800)472-8086. View us online at www.chathamwealth.com.