As the holidays approach us, there’s more to worry about than what kitchen gadget you will receive as a gift that you have no need for and didn’t ask for in the first place. Those worries go for capital gains distributions as well.
Every year, mutual fund companies announce any applicable capital gain distributions for a variety of their funds. A capital gains distribution is the result from the mutual fund’s portfolio and the turnover that happens within. While stocks and bonds are sold throughout the year, only towards the end of the year (typically) do funds announce how large the distribution will be, which is then taxed to the shareholder at the capital gains tax rate if held for more than 365 days or at the shareholder’s ordinary income tax rate if held less than a year.
Now while we can’t help you with the kiwi slicer your brother-in-law thinks you can’t live without, we can help with mitigating the effect your portfolio has on your taxes in 3 ways:
- Identify the mutual funds in your taxable portfolio (i.e. accounts registered as trusts, individual, transfer-on-death, joint-with-rights-of-survivorship, etc. but not tax-deferred accounts such as 401(k) plans and IRAs). Head over to the mutual fund family’s website and look around the tax information section, or do a Google search for the fund family’s 2019 capital gain estimates, such as this one for T. Rowe Price; more than likely the first search result or two will lead you here. If a fund is estimating a rather large capital gain distribution like Harbor International did in 2018, you can sell the fund before the date of record and not receive the capital gain distribution. However, selling the fund and avoiding the distribution should be measured against the current unrealized gain in the position, if applicable.
- Implement a tax-loss harvesting strategy. This is more difficult in the 11th year of a bull market but depending on the time of purchase and asset class of the investment, any position that is currently worth less than what you initially invested can be sold, with the difference offsetting your gains. This strategy is most common at the end of the year but should be considered throughout the calendar year as markets experience volatility.
- Focus on asset location between taxable and tax-deferred accounts. This is not always easy as some investors have a bulk of their liquid wealth resulting from a company 401(k) plan, or from long-term held stock investments with low basis resulting from prudent savings earlier in life. But when possible, active mutual funds should be utilized in tax-deferred accounts where annual capital gains distributions will not be taxed because these plans are only taxed when withdrawals are made. On the other hand, we believe taxable accounts should focus on tax-efficient exchange-traded funds (ETFs), which are less likely to pay capital gains distributions.
Of course, your financial advisor should be actively pursuing these strategies if you are engaged with one. If not, consider implementing the above tactics; maybe you’ll have enough tax savings left over to purchase a new gift for your brother-in-law and you can keep that kiwi slicer for yourself whether you need it or not.
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Tax services are not offered through, or supervised by, The Lincoln Investment Companies.
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