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 At the end of this year, many mutual funds are expected to
distribute sizeable capital gains to shareholders who will have to
pay taxes on them.
That is true of stock mutual funds that sold off last week after
carrying forward big gains from 2013, and also may be true of the
popular Pimco Total Return Fund, which was thrown a curve when star
manager Bill Gross left Pacific Investment Management Co in late
September and the Pimco Total Return Fund was forced to sell
appreciated bonds to pay off shareholders who left in his wake.
Here is why: Mutual funds must distribute realized gains to their
shareholders every calendar year. Managers of both bond and stock
funds have seen sizeable gains for several years running, but have
not had to sell shares and realize those gains. This year, there
have been some big selloffs that may have forced the managers to
sell winning securities and realize those gains for tax purposes.
For individual investors, those gains might hurt more than they
would have over the last few years, because a lot of investors have
been offsetting their taxable gains for years with losses they
carried over from the 2008-2009 rout. Now, with most of their losses
used up, they will have full exposure to the gains. Long-term gains
are typically taxed at 15 percent; those in the top tax bracket face
a capital gains tax rate of 20 percent.
The Pimco Total Return Fund, for example, saw $48.4 billion in
outflows through September, according to data from Morningstar and
Pimco, and some analysts believe that could result in unusually high
taxable gains.
"If PIMCO sold bonds to meet redemptions at a gain, the remaining
shareholders could suffer an inordinately large tax consequence,"
said Tom Roseen, an analyst with Lipper, a Thomson Reuters company.
Through September, research firm Morningstar was estimating that
Pimco Total Return Fund would pay out 2 percent of its net asset
value in taxable gains, a high figure but one not out of the fund's
long-term historical range.
That means a person with $50,000 in that fund would see a $1,000
taxable gain, and - at the most common 15 percent capital gains tax
rate - owe $150 in federal taxes on it.
Last year, the Total Return fund distributed 0.66 percent net asset
value in gains. The year before, it distributed 2.31 percent, Roseen
said.
Stock fund investors could be harder-hit, said Morningstar analyst
Russel Kinnel. He estimates that U.S. domestic stock funds might be
sitting on gains of around 20 percent and could end up paying 16 or
17 percent of their value to shareholders as gains. (When that
happens, fund shareholders do not actually cash in the gain; they
end up with more shares at lower prices.)
Note that none of this affects investors who hold mutual funds
through tax-favored retirement accounts. They do not have to pay
annual taxes on fund earnings.
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For everyone else, there are very few ways to minimize the impact of
those taxable gains. Here are some strategies that might help.
- If you bought recently, you might consider selling quickly. If you
have not seen much of a gain in a fund you bought, or if you have
actually sustained a loss, you can sell shares and either use your
capital loss to offset other gains, or at least get out before the
gain is distributed. That strategy will not work if you have been in
the fund long enough to rack up your own gains - then you will just
have to pay taxes on them when you sell.
- Think before you buy. The people who will get hardest-hit by these
year-end mutual fund taxes are people who have not owned the funds
for long. They buy in just before the distribution, miss out on the
actual gains, but get hit with the taxable distribution anyway. Do
not buy any funds this year until you have checked with the fund
company to find out when it is distributing 2014 gains. If you think
it is a fund that is sitting on big gains, wait until that date
passes before making your purchase.
- Take losses. If you own any stocks or funds that have lost money
since you have held them, sell and reap the loss. It can offset
those fund gains.
- Relax. At 15 percent for most people (20 percent for top tax
bracketeers), the capital gains tax is still much lower than regular
income taxes. And there are worse things than having to pay taxes
because you made money.
(Editing by Matthew Lewis; Linda Stern is a Reuters columnist. The
opinions expressed are her own. The Stern Advice column appears
monthly, and at additional times as warranted. Linda Stern can be
reached at linda.stern@thomsonreuters.com; She tweets at http://www.twitter.com/lindastern;
Read more of her work at http://blogs.reuters.com/linda-stern)
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