Tax Strategies for Fund Investors

Taxes are a greater drag on net investment returns than expenses and fees, according to a study by Rob Arnott of Research Affiliates. Most investors leave a lot of money on the table by overlooking important tax tricks of funds and focusing on taxes only near the end of the year.

Don’t let that happen to you. Review these simple rules about mutual fund taxes and keep them in mind all year. As markets change, consider tax-wise actions to take with your funds. You want to own the right assets in the right accounts when possible. Owning the right investments for you comes first. To the extent you can, own the assets in the most tax efficient accounts for them. If most of your money is in an IRA or 401(k), you might not be able to have all the right assets in the right accounts. That’s one reason I recommend tax diversification. It’s a good idea to have taxable accounts, tax-deferred accounts and tax-free accounts. A good general rule for putting the right assets in the right accounts is to hold assets that already receive tax advantages in taxable accounts. Stocks, mutual funds and other assets you’ll hold for more than a year should be in taxable accounts to take advantage of long-term capital gains. Stocks that pay qualified dividends usually should be in taxable accounts. Tax-deferred accounts should hold assets that earn short-term capital gains and taxable interest. Tax-free accounts, such as Roth IRAs, also should own these types of assets. Real estate investment trusts (REITs) are a hybrid but generally should be held in tax-deferred or tax-free accounts. You might want to hold treasury bonds or treasury-only mutual funds in taxable accounts, because their interest is exempt from state income taxes. Those are general rules. Let’s move beyond those basics to a higher level of mutual fund tax planning. You know that a mutual fund avoids income taxes by distributing to shareholders most of its net interest, dividends and capital gains. Only the shareholders are taxed on the income. Shareholders on the date of the distribution pay the taxes. If you buy shares in a taxable account the day before a distribution, the distribution will be included in your income for the year, though it really is a return of your investment. The net asset value of the shares is reduced by the amount of the distribution. When you’re investing or considering an investment in a mutual fund, know its regular distribution dates. You want to make new investments just after, not before, a distribution.


Source: Investor king