These Taxes Can, and Should, Be Avoided
One of the drawbacks to a decade-long up market is that there are large amounts of unrealized gains.
Mutual funds with these gains will distribute some, hopefully not all, to shareholders in December. Those shareholders will then be held accountable for the taxes due on said gains…yes, even if those shareholders didn’t actually sell the funds to begin with.
It’s a wonderful aspect of the tax code in relation to how mutual funds work and is just another reason why ETFs are so much more beneficial. But we’ll save that conversation for a different day.
So, let’s say you have $100k in American Funds Growth Fund of America. Towards the middle of December you will receive a distribution of around $10k, just from capital gains. No big deal…except when you go file your taxes next year, you’ll have to pay tax on that $10k. Depending on your tax bracket you’ll pay 0, $1,500 or even as much as $2.300. Nice job!
“But”, you say to your tax guy, or Turbo Tax, “I didn’t sell anything. Why do I have taxes due???”
Your tax guy will simply say, “take it up with Congress.” And then you’ll stroke that check to the IRS.
Unfortunately, depending on your lot in life, this capital gain distribution may cost you even MORE in taxes because of potential taxation on Social Security benefits, Medicare premiums, and even take a 0 taxed asset and make it 15%. Wonderful, right???
Oh, so just in case you think it’s only active-managed investment firms that will send you capital gain distributions to pay tax on, here is the video I did on the Vanguard year end distributions. Not favorable there either. Fidelity? Think again. Any fund company that has large capital gains will send you a taxable distribution.
Over the next few emails, I’ll share with you some strategies on how to minimize if not outright avoid these taxable distributions.
But for now, just watch what your fund company says regarding year end capital gain distributions. It’s not going to be fun when the taxes come due.