Question on taxable mutual funds

[Rob Base 2.0]

I have a dumb question. Since I have mostly done 401K / IRA investing, I am wondering how do taxes work if you just get a "regular" taxable mutual fund?

Is it that you don't pay any taxes until you start cashing it out? And then it is a 15% tax on whatever gains (capital gains?) it has at that time? or how does it work?

Thanks

[tallguy]

Feb 1, 2018 17:50:30 GMT -5 Rob Base 2.0 said:

I have a dumb question. Since I have mostly done 401K / IRA investing, I am wondering how do taxes work if you just get a "regular" taxable mutual fund?

Is it that you don't pay any taxes until you start cashing it out? And then it is a 15% tax on whatever gains (capital gains?) it has at that time? or how does it work?

Thanks

You will get a statement each year for the dividends and capital gains distributions.  Those are taxable each year and are added to your cost basis.  The tax is dependent on your bracket.  The gain from price appreciation is not taxed until you sell.  

[CCL]

The capital gains rates apply to long-term (held 1 year+). If you sell with a short-term (less than 1 year) they are taxed at the regular income tax rate. You may sometimes have to pay tax on distributions, too, depending on whether they are qualified or not.

[CCL]

Here's more info on qualified dividends from Fidelity:

www.fidelity.com/tax-information/tax-topics/qualified-dividends

It took me a while to understand how they work, but your year-end 1099 will separate and list them according to whether they are qualified or not.

[Deleted]

Feb 1, 2018 19:01:32 GMT -5 tallguy said:

You will get a statement each year for the dividends and capital gains distributions. Those are taxable each year and are added to your cost basis.  The tax is dependent on your bracket. The gain from price appreciation is not taxed until you sell.  

I have a lot of investments outside of IRAs and this is one of the reasons it's so hard for me to predict taxable income from year to year. It's typically in December that mutual funds declare capital gain distributions even though they buy and sell throughout the year due to people pulling money out, re-balancing, weeding out underperforming stocks, or whatever. Sometimes their site will give estimates of likely distributions in November, but regardless, it's very hard to guess at your taxable income till they come in. (Good problem to have, I know.)

As tallguy noted, these distributions are added to your tax basis. Example: You have $10K in a mutual fund that you bought for $8K and they make a $1K distribution. Your tax basis is now $9K because you've already paid taxes on $1K of the gain. This is true regardless of whether or not you reinvest the distribution. All the major brokerages do these calculations for you when you sell.

And yes, long-term distributions are reported separately from short-term so they get the 15% rate.

One thing you can check when researching mutual funds is the turnover rate- the higher it is, the more frequently they're buying and selling, which can not only run up transaction costs, but also capital gain distributions. 

[CCL]

I agree it can be difficult to predict the tax bill on distributions. I usually rely somewhat on the previous year's since I generally don't change the funds I'm in.

You can research the funds and see what they paid out the last couple of years.

[Rob Base 2.0]

thanks all! i appreciate the info.

[phil5185]

One thing you can check when researching mutual funds is the turnover rate- the higher it is, the more frequently they're buying and selling, which can not only run up transaction costs, but also capital gain distributions.

One approach is to buy a mutual fund index, the manager is forbidden to deviate from the index allocations - so there is no buying/selling.