[ad_1]
Bloomberg/Contributor/Getty Images
Taxes can be complicated, and for investors in mutual funds, they can be very complicated. When you own mutual fund shares, there may be taxes on dividends and income in addition to capital gains tax when you sell your shares in the fund. You don’t even have a say in when to take profits in the fund’s holdings because the decision is made by the fund manager on behalf of all shareholders.
But once you break things down into different types of taxes, it’s really easy to understand. Here are some key mutual fund taxes to be aware of and some strategies on how to minimize those taxes.
Mutual fund taxes
Mutual funds can be a great choice for investors because they allow you to hold a variety of securities for a relatively small investment. But investing in mutual funds means you don’t have control over the individual holdings in the fund, which is at the discretion of the fund manager. The fund’s value or net asset value (NAV) rises and falls based on the performance of the holdings in the fund.
Taxes on mutual fund shares, even if you still own the fund, can arise in two ways:
- interest and dividends; If the fund owns securities that pay dividends or interest, the fund distributes your share of those payments to you and you pay taxes on that income. Some mutual funds, such as municipal bond funds, focus on investments that are exempt from federal income tax. If you receive dividends or interest from funds you hold, you may receive an IRS tax form showing your income for the year. The form can come from the fund company itself or from an online broker.
- Capital gains: The fund manager may sell the securities in the fund for a profit, triggering capital gains tax. The tax impact depends on how long the fund has held the shares sold. The capital gains are typically distributed once a year to the fund’s shareholders, who are taxed on the gains.
For more details on investment income taxes, see IRS Publication 550.
Tax payable on mutual funds when selling shares
If the securities held in your mutual fund perform well, the fund’s NAV will appreciate, giving you a profit on your initial purchase. You’ll need to pay taxes on this excess, but figuring out exactly how much you owe can be complicated.
If you buy your shares at once, the calculation will be relatively simple. You subtract the price you paid for the stock from the price you sold it for, and the difference equals your dividend yield. But many people buy mutual funds over time, which means you’ve paid many different prices for your shares. You can use the average cost of all the stocks you own to calculate your profit, or you can use specific stocks with a specific cost basis.
How long you hold your shares also matters. If you own the shares for more than a year, you may get a break on the capital gains tax rate because the gain is considered long-term. For gains on shares held for less than one year, you pay tax at ordinary income rates.
How to reduce taxes on mutual funds
Taxes on mutual funds are a sign that you’ve made some investment income or profit, so they’re not all bad. But avoiding taxes can help you achieve higher long-term returns. Here are some great ways to minimize tax on mutual fund investments:
- Hold stocks in tax-advantaged accounts: One of the easiest ways to avoid taxes on mutual fund investments is to hold stocks in a tax-advantaged account such as a 401(k) or traditional or Roth IRA. Your investments are allowed to grow tax-free, which means you don’t pay taxes on the distributions you receive or the gains you realize. With a Roth IRA, you also don’t pay taxes on withdrawals.
- Hold funds for a long time; By holding the fund for more than a year, you can pay tax on the long-term capital gains rate, which is a huge advantage for many investors.
- Avoid certain types of money. If you want to avoid taxes, you may want to avoid dividend-oriented funds or funds with high portfolio turnover, both of which can generate large guaranteed returns. Index funds may be your best bet.
- Collecting tax losses; Using a tax loss harvesting strategy involves selling certain investments at a loss to offset your gains, allowing you to pay less in taxes.
You can limit your tax exposure by holding Exchange-Traded Funds (ETFs) instead of mutual funds. ETFs often hold the same investments as their mutual fund counterparts, but are not required to distribute guaranteed capital gains, making them more tax efficient.
at last
Taxes on mutual funds can be complicated because you may pay taxes on dividends and fund gains even before you sell your shares. Of course, when you decide to sell, you’ll be taxed on any gain on the fund’s value. An easy way to avoid this is to own mutual funds in tax-advantaged retirement accounts like IRAs and 401(k)s. You can also ensure that you hold the investments for the long term, so if you owe taxes, you will pay a lower long-term capital gains rate.
[ad_2]
Source link
