More insight on rising mutual fund tax bills…

On August 8, 2014

MONEYMany advisors aren’t aware that the pass thru capital gains distributions of actively managed mutual funds are not included as part of the funds expense ratios. In addition to this, the trading fees inside the mutual fund are not included in the funds expense ratios either.

Both the pass-through capital gains distributions and the funds trading fees are reported as separate line items outside the expense ratios in separate disclosure sections in the funds prospectus, which is very misleading to investors.


Mutual Fund Tax Bills are Rising

Investors may have noticed recently that their mutual fund tax bills have been rising. In fact, the average capital gains distribution for U.S. equity funds rose from 6.9 percent in 2007 to 19.3 percent in April 2014.

Mutual fund owners who hold the assets in a taxable account need to pay taxes on those distributions, even if they reinvest the money. So investors may want to take this opportunity to consider strategies for dealing with payments in the future. They’ll end up with more money if they can postpone paying capital gains as long as possible, since money in today’s dollars is worth more before any future inflation, and because holding onto the money lets investors take advantage of the power of compounding.

Morningstar also suggests the following actions to help investors limit their tax bill.

  • Invest as much as the law allows into tax-sheltered accounts.
  • Consider tax-managed funds, as they may generally result in superior returns after taxes.
  • Consider exchange-traded funds (ETF), if they are diversified, low-cost, and have low turnover.
  • Stay away from funds with large returns over the past three years, as they will also generate the largest tax bills

Read Morningstar’s full article on mutual fund tax bills

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