As a mutual fund owner, there are a few ways to get returns. One is by selling shares of the mutual fund at a gain. The other is to have internal gains the manager has realized and passed through to the investor, along with other dividends and interest. We call the latter a capital gain distribution.
The short of it…
Capital gains distributions must be made by a mutual fund manager because tax law dictates that substantial portions of investment income and capital gains must be paid to investors. Shareholders will pay long or short-term capital gains tax based on how long they’ve owned the fund. However, this doesn’t mean that investors are losing money. Investors can either take capital gain distributions in cash or reinvest them. If capital gains are reinvested, the number of shares in the account will increase, leaving the total value of the account unaffected by the distribution.
Here are a few tips for dealing with capital gains distributions:
If you already own the fund, do nothing! Enjoy your payout but know you will owe tax on the gain.
If you are going to buy the fund… wait! Otherwise, you’ll need to pay taxes on gains that you didn’t get to enjoy throughout the year.
If you are already planning to sell that fund, go ahead and sell ahead of the distribution. Don’t sell it just to dodge a distribution. There will likely be other tax consequences!
And the long of it…
Another thing to consider is if your mutual fund is “tax-friendly” or if an Exchange Traded Fund (ETF) is better.
A mutual fund manager may rebalance the fund by selling securities to accommodate shareholder redemptions or to reallocate assets. The sale of securities within the mutual fund portfolio creates capital gains for the shareholders, even for those who may have an unrealized loss on the overall mutual fund investment.
In an ETF, the manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets that approximate the entirety of the ETF investment exposure. As a result, the investor may not be exposed to as much capital gains. Not all ETF index funds are immune though! For example, they may be forced to sell to hit rebalancing targets. So-called strategic-beta funds also construct their portfolios based on a set of rules that can result in more frequent changes and lower tax efficiency than broad-market index products.
The chart below is a great example of why we apply our Tranches of Income strategy to our asset allocations. Going back to the Great Depression, there have been 15+ major downturns in history. Only three of these downturns took more than 36 months to recover (one of which WAS the Great Depression). The others averaged about 18 to 36 months.
The Great Recession of 2008 only lasted 16 months, but to most investors it felt like ETERNITY. It then took about three years for people to make their money back. The whole process lasted about five years from start to finish. That’s why at CAISSA, we ALWAYS keep about 5 to 7 years of withdrawal needs earmarked in short term instruments. It may feel a little boring, but that’s the point! When the next market downturn happens, our clients will have the assurance that they will still meet their cash flows needs.
Even if you’re not retired, you can still rest easy because downturns are natural… but so are recoveries!
There will be big changes in how people give to charities this year. The tax bill that was passed in December included many provisions that will likely have a lot of people changing from itemized deductions to receiving a much simpler $24,000 deduction (for joint filers). By doing this, people will likely think twice before making a charitable donation because it will probably no longer be deductible on their tax return since they don’t itemize. If you are one of those people, we have a few ideas for you.
One idea, if you are over age 70 ½ and receive Required Minimum Distributions (RMDs), is that you can choose to donate part or all of those RMDs to charity! The IRS has a provision that allows this donation to go directly from the IRA to the charity, counting as part of the required distribution. This is called a Qualified Charitable Distribution. This will have the effect of the income not hitting your tax return at all and so is actually better than a deduction.
Another option is to set up a Donor Advised Fund (DAF). This is an account that allows you to make lump sum contributions to the fund and claim the corresponding deduction on your tax return in the year made. Then, at your leisure over as many years as you would like, you can direct the DAF to dole out any dollar amount of your choosing to any charity. In order to make sure you can deduct it on your tax return, we suggest “bunching” your donations so that you make sure your itemized deductions are greater than your standard deduction. For example, you can donate 5 years’ worth of donations to the DAF to bump you into itemizing on your tax return one year. Then, you can divvy out the donations at your leisure over the next 5 years until you’re ready to do it all again!
And of course, you can ALWAYS give to charity without worrying about making it a tax deduction.
We take great pride in our approach to financial planning. The value we bring to our clients is in our drive to detail, experience, and the knowledge to not only think ahead, but to think outside of the box.
Torpedoes are toxic events that can drastically alter your retirement vision. Because we use our torpedo proofing process with our clients, they tell us they find comfort and confidence in always knowing that their retirement vision is secure.
We have more and more information coming out about the tax bill that will likely be voted on this week. I have put together a few “Cliff Notes” on the details in the bill that will likely pertain to you.
There are a few highlights below or click on the link to get the full summary. There will be a lot of planning to do in 2018!!!
If you have any questions, please don’t hesitate to call or email me.
New Brackets: The TCJA did not cut the number of brackets as much as they first indicated and these brackets are set to sunset in 2025. See the table in the full summary
Capital gains will be 0% up to $38,600 individuals/$77,200 married. After that it is 15% and jumps to 20% for $452,400 Individual/$479,000 Joint (more marriage penalties!). The 3.8% medicare surtax on those making $200,000 individual/$250,000 married will be added to the capital gains tax.
Standard deduction and personal exemptions MERGE. You will no longer get an exemption deduction for each person in your family. Instead, the standard deduction will be $12,000 for individual/$24,000 married
State income taxes AND Real Estate taxes are COMBINED and limited to $10,000. This will have a huge impact on clients that are used to deducting state income taxes AND real estate taxes.
Home equity indebtedness will NO LONGER be deductible. However, Home equity debt used specifically to make a substantial improvement on a house IS deductible. So it is about what you use the money for that will make it eligible or not.