Give Less to Uncle Sam

We know you're all good, apple-pie-eatin', Mom-lovin', gas-guzzlin' Americans, but patriotism doesn't mandate that you pay more in taxes than necessary. Unfortunately, that might be what you're doing, according to a new study by mutual fund info-snooper Lipper.

According to the study, almost one-fourth of the typical mutual fund's returns are consumed by taxes. We're talking about the capital gains and income distributions made by funds each year to shareholders. When you sell the fund, you'll have to pay additional capital gains (assuming you made a profit, which -- historians tell us -- did happen in the stock market some time ago).

But don't despair, all ye fund-lubbers. Thanks to the Mutual Fund Tax Awareness Act of 2000 (which didn't take effect until this year), fund families must provide the after-tax returns in their prospectuses. These returns will be based on the top tax bracket, so those numbers won't be as bad for most people. And if the fund is in a tax-friendly account such as an IRA, taxes aren't a consideration at all.

But if you have mutual funds in a taxable account, here are some ways to keep more of your money by giving less to Uncle Sam:

  • Invest in index funds: Not only do index funds charge virtually nothing in fees (0.2% to 0.4%, compared to the industry average of 1.25%), but the turnover is very low.

  • Choose individual stocks: If you're comfortable evaluating businesses, then buying and holding the stocks of good companies is very tax-efficient. It can also be cheap, if you use a discount broker or a dividend reinvestment plan.

  • Look for tax-efficient funds: These are funds that seek to mitigate the damage wreaked by taxes. According to the Lipper study, the after-tax returns of tax-efficient funds led the pack in many categories.

  • Keep funds in IRAs: If you're infatuated (trust us -- it's not love) with a fund that has a so-so after-tax record, keep it in an IRA, where earnings are tax-deferred or tax-free (depending on if it's a traditional IRA or a Roth, respectively).

  • Don't invest in a fund right before distributions: It doesn't matter how long you've held the fund; if you're an owner on distribution day, you'll have to pay the taxes, even if you got in just a week beforehand. Call the fund family and inquire about distribution plans before investing. Most funds distribute income and capital gains toward the end of the year, but distributions occur at other times, too.

Have a friend who's addicted to keeping actively managed funds in a taxable account? Stop enabling him, and send him this article by clicking "Email this article" at the bottom of the page.




Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1151251, ~/Articles/ArticleHandler.aspx, 9/17/2014 3:46:58 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...