It's that time of year when mutual funds and exchange traded funds are estimating their capital gains distributions. Funds that sell investments for a profit will pass those gains on to investors, who will be responsible for paying the taxes. But it's important to note that Investors in 401(k)s and IRAs aren't on the hook - just investors in taxable accounts.
If you're thinking about investing that cash you got from Grandma for the holidays or making your IRAs contributions before year-end, check to to see if the fund you're interested in has already made its distributions. You don't want to hop into the fund just before the distribution, paying for gains you didn't have, do you?
For those of you who are invested and want to minimize your gains, here are two common suggestions that I shared in a column two years ago. Be glad it's not December 2008. When I wrote the piece, investors were taking a major punch in the teeth from the market declines only to turn around get punched in the gut by a tax bill from their fund caused by massive redemptions that forced fund managers to sell long-time winners at the worst time.
It's a lot nicer to pay taxes when investments are rising!
So here are two strategies, but investors must act quickly; most funds make their capital gains distributions in December, but others will distribute any day now:
- Sell losing investments by Dec. 31 to offset the gains.
- Get out of the fund before it makes its distribution. Only shareholders of record on the day of distribution owe capital gains, even if you've been holding the fund for years. On the flip side, if you buy a fund the day before it makes its distribution, you'll be on the hook for paying tax, which is why advisers suggest that investors take care when buying mutual funds toward the end of the year.
Investors who are satisfied with their portfolios may decide that timing the distribution is not worth the hassle, or that being out of a volatile market for even a few days could mean missing out on gains. But it's a good idea to learn about a gain sooner, not later, to prepare to pay Uncle Sam.