Mutual Fund Distributions – Part 2
Joel Dresang: Ron, let’s talk today about mutual funds and capital gains distributions to mutual fund owners. Investors are seeing more capital gains distributions from mutual funds because of the stock market rising. Can you talk a little about that?
Ron Hansen: Mutual funds own many stocks for many, many years. And there may be times when they hold onto something into a subsequent year, like 2014, that went up in value quite handsomely during the prior years. And if they sell it during this year, you’re going to realize that entire gain that has accrued over the years. And you may look at your account and say, “Gosh oh Friday! I didn’t go up that much. How did I get this transaction?” But you get the cumulative gain on that transaction.
Joel: And if that’s in a taxable account, then you have to worry about short-term gains, which are investments that the mutual fund held for less than a year, and for long-term gains, which they hold for more than a year.
Ron: Right. I would think that the larger gains would come from the long-term category. These are items that they may have held onto for a number of years. And they have increased, but they didn’t dispose of it as it was going up. Now they think that it may have run out of steam and it’s time to make that sale. And the entire gain will be realized in this tax year.
Joel: So what are some of the strategies that you would use if you were a mutual fund owner and you got capital gains distributions, and you wanted to try to offset those?
Ron: Look at your entire portfolio. Determine if there are items in the portfolio that have a loss, based on current value. It may be a gain for the life of the investment. But due to reinvestments, it may be at a loss. And you may want to liquidate those investments to help offset some of these capital gains.
A second option might be – and if you’re not funding retirement accounts to the maximum – if you’re still working, would be to look at increasing your 401(k) deposits, if you can do that. Also, you might be eligible for deductible IRA contributions. That would be another way to reduce the total income that you’ll experience from these capital gains.
Joel: But when considering things like this, tax implications shouldn’t outweigh investment decisions overall.
Ron: Correct. If the tax that you have to pay is a big concern, but the transactions that you might make to offset those gains will cause you further harm, you should just go on and pay the tax.
We’re in this to make money, and if you have capital gains, that means you made money, and that’s a good thing.
I’ve told many of my clients over the years, do not let the tax tail wag the dog. And that would apply to what we just talked about, where you don’t make a second move to try and offset the first move. You look at the quality of your investment, and whatever happened, the tax impact is accepted, and you don’t let the tax cause you to change your portfolio.
More information IRS Publication 550, Investment Income and Expenses
Joel: And we will have links for more information on this on our website and on our YouTube channel.
FAQ About Taxation for Mutual Fund Investors, Investment Company Institute Mutual Fund Distributions – Part 1
Ron Hansen is vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May
(initially posted April 7, 2014)
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