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Tips for Year-End Fund Distributions

11/17/2006 12:00 am EST


Janet Brown

President, FundX Investment Group

Fund expert Janet Brown weighs in on some solid advice for year-end tax planning. Here she offers several tips on keeping your tax bite to a minimum just by knowing the rules of year-end fund investing…

“Many mutual funds make capital gain and income distributions at year-end. These distributions are taxable to you as a shareholder whether you receive the distributions in cash or have them reinvested in additional shares.

“If you’re upgrading in an IRA, pension plan, or other tax-deferred account, relax! None of this tax planning applies to you.

“There are two kinds of distributions a fund can make:

  1. Capital gains are generated when a fund sells securities for more than they paid for them. There are two kinds of capital gains: Long-term and short-term. If a fund held a security longer than one year, the gain is long-term. Short-term gains come from securities held less than a year, and are taxed at ordinary income rates. Taxes are currently 15% on long-term gains.
  2. Income a fund earns from interest and dividends is passed along (after expenses) to shareholders of the fund. Ordinary income distributions are taxed at your regular income tax rate. Some funds may distribute qualified income, which is taxed at a lower rate.

“Here’s what to do:

“Proceed with caution this time of year when you are buying or selling funds. If you are buying a fund, you may want to wait until after the fund’s ex-dividend date to avoid a tax liability. Remember that if you buy a fund that is about to make a big distribution, you may be buying additional taxes. Selling a fund, though, is also a taxable event. If you sell a fund before it makes a distribution to avoid the tax consequences, you’ll still owe taxes on any gains you made from your investment in the fund.

“Harvest losses. If you are holding a fund that is worth less than what you paid for it, consider selling. This is a good time to review your portfolio and harvest losses as they can be used to offset capital gains–potentially minimizing your April tax bill. Regardless of what portfolio adjustments you decide to make, watch out for redemption fees from the fund company and from your broker.

“Be informed. Since most fund companies don’t have distribution estimates available until later in November or December, contact funds directly before making purchases to see if and when they plan on making distributions this year.”

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