Mutual funds can be a great, easy way to start saving for retirement. But before you sign any checks, you may want to wait just a little longer.

At the end of the year, funds typically make their annual distributions, which you can elect to receive in cash, or in the form of additional fund shares. I've rounded up a few of this year's examples:


Expected Distribution per Share

Top Holdings Include

Oakmark Fund (OAKMX)


Hewlett-Packard, Disney (NYSE:DIS), EnCana (NYSE:ECA)

Legg Mason Value Trust (LMVTX)


Sears (NASDAQ:SHLD), AFLAC (NYSE:AFL), Capital One Financial (NYSE:COF)

Ariel Fund (ARGFX)


Newell Rubbermaid (NYSE:NWL), IMS Health (NYSE:RX), J. M. Smucker

Source: Morningstar, fund company websites.

Funds don't pay income tax, but they're required to pass their earnings on to shareholders. If you're purchasing funds for a taxable account, that'll leave you on the hook with the IRS, making now a less-than-ideal time to buy in. Since the fund's price will drop by the amount of the distribution when it's made, you won't even come out ahead by buying shares right before the distribution. In fact, if you invest at the wrong time, you'll get socked with taxes on gains the fund made before you were ever a shareholder.

Hooray for a lousy 2008
Fundholders won't get hit quite so hard this year, in part because 2008 was such a brutal slog for the market. Funds' distributions often include the capital gains they've made by selling long- and short-term holdings. While these sums can also be taxable, many funds have carried last year's tax losses forward into 2009, offsetting the impact of this year's gains. That's why none of the funds in the table above anticipate making an additional capital gains distribution.

As long as you keep fund distributions in mind before you buy, you'll save yourself a surprise bill from the IRS. You can look up information on distributions at most fund company websites -- or just give the company a call to ask when the payout will be made, and how substantial it will be.

Among the funds above, the Ariel Fund's penny-per-share distribution is small enough that it might be worth any meager tax hit. Even the Oakmark fund's distribution isn't a whopper, since it's less than 1% of the fund's current price.

Just be aware that when capital gains join the payout party, tax bills can skyrocket. Consider the Dreyfus Greater China (DPCCX) fund, which gained an impressive 61% in 2007. That year, the company distributed $8.41 per share in capital gains, representing more than 20% of the fund's total assets at the time. Unprepared fundholders got hit with a hefty tab from Uncle Sam.

If you're keen to buy into mutual funds before the New Year, proceed with caution. This further Foolish advice about mutual fund investing probably can't hurt, either:

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. AFLAC and Walt Disney are Motley Fool Stock Advisor picks. Walt Disney, Sears Holdings, and J. M. Smucker are Motley Fool Inside Value recommendations. The Fool owns shares of IMS Health, which is a Motley Fool Hidden Gems pick. Try any of our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.