Dec 01, 2021
By Sarah Specht, CFP® Investment Advisor Representative at World Trend Financial
From a tax planning viewpoint heading into the next tax season, here are some mutual fund tips to avoid a tax surprise. Unless noted otherwise, these tips assume your mutual fund investment is outside of a retirement account like a 401(k) or traditional IRA.
- Long-term gains create a potential tax benefit. With the Dow Jones, Nasdaq and S&P 500 indexes having grown between 10% and 20% since January 1, there is a good chance the stocks comprising your mutual funds have grown in value. Whenever possible, time the sale of your appreciated mutual fund shares to avoid short-term capital gains (assets that are held less than one year). Short-term capital gains are taxed as ordinary income, whereas long-term capital gains often have a lower tax rate.
- Time your sales to account for dividend distributions. If you have owned appreciated mutual fund shares for more than 12 months and want to sell, find out when your fund distributes dividends. Dividend tax rates could apply and may be very high. Selling before the dividend payout may keep all your earnings as long-term capital gains.
- Recordkeeping is important. Keep detailed records of every transaction. While brokers are now required to report your cost basis to the IRS, the information they provide may be in error. It is best to develop a filing system to confirm the accuracy of what your broker is reporting.
- The IRS wants your cost basis. Know the original cost of each share in your mutual fund. This basis includes any costs related to the transaction like brokerage fees. It can get complicated as your mutual fund buys and sells shares in underlying individual equities that make up the mutual fund. It is even more complex if your mutual fund automatically reinvests any dividends.
- Transfers could cause a tax event. Ask your broker or agent if there will be a capital gain if you transfer mutual fund shares from one account to another. What appears to be a transfer may actually be a sale of shares in one fund and a purchase of shares in another. This can create a taxable event if not handled properly.
- Dividend distributions can impact the fund’s value. Similarly, if you have had your eye on a particular fund, understand the historic payout of dividends. The cost of the mutual fund might be artificially higher right before a dividend payout. To make matters worse, you may even get a dividend distribution that is taxed at higher ordinary income tax rates for gains that occurred before you purchased the mutual fund.
- Plan withdrawals from retirement accounts to be tax efficient. Remember that withdrawals from mutual funds within retirement accounts like 401(k)s and traditional IRAs are taxed as ordinary income. So, plan these sales accordingly.
- Look at mutual fund costs. Disclosure rules require fund managers to adequately display the costs associated with each mutual fund. All things being equal, consider these operating costs when deciding between similarly performing mutual funds in a category.
Please reach out to Sarah at firstname.lastname@example.org to discuss your specific circumstances, or any of the investment advisor representatives by calling 319-364-3041 in Cedar Rapids, or 319-339-4884 in Iowa City.