Ten ideas to maximize the value of your investments:
Mutual funds benefit from the long-standing belief that they allow investors to diversify their holdings without buying individual stocks. But there are plenty of tax surprises for the unwary investor. From a tax planning perspective, here are some great mutual fund tips. Most of these tips assume that your mutual fund investment will not be in a retirement account such as a 401 (k) or traditional IRA unless otherwise noted.
Records are important. Keep a good record of every transaction. While brokers are now required to report your cost base to the IRS, the information they provide may be inaccurate. It is best to develop a digital or paper filing system to verify the accuracy of your broker’s reports.
The IRS wants your cost base. Know what each share of your mutual fund costs. This basis includes all costs associated with the transaction such as brokerage fees. It can get quite complicated when your mutual fund buys and sells shares in the individual underlying stocks that make up the mutual fund. Things get even more complex when your mutual fund automatically reinvests dividends.
Remittances can lead to a tax event. Ask your broker or agent if there will be a capital gain if you transfer mutual fund shares from one account to another. What looks like a transfer may actually be a sale of shares in one fund and a purchase of shares in another. This can result in a chargeable event if not handled properly.
Long-term profits create a potential tax advantage. Whenever possible, plan your sales to avoid short-term capital gains (assets held for less than a year). Short-term capital gains are taxed as ordinary income, while long-term capital gains are often taxed at a lower rate.
Schedule your sales to take dividend payouts into account. If you’ve owned and sold valued mutual fund shares for more than 12 months, find out when your fund is paying dividends. Dividend tax rates may apply and they can be very high. Selling before the dividend is paid can hold all of your profits as long term capital gains.
Dividend payments can affect the value of the fund. When you have a specific fund in mind, you should understand its historical dividend payout. The mutual fund’s cost could be artificially higher just before a dividend is paid out. To make matters worse, you may even receive a dividend payout, which is taxed at higher ordinary income tax rates on profits made prior to purchasing the mutual fund.
Benefit from tax-privileged investments. Maximize your contributions to tax-deferred plans, especially those with equivalent contributions from your employer.
Schedule retirement account withdrawals tax efficient. Remember, mutual fund withdrawals within retirement accounts like 401 (k) s and traditional IRAs are taxed as normal income. For this reason, you should plan your withdrawals to be as tax-efficient as possible.
Charitable gifts from mutual funds have a tax advantage. As with individual stocks, consider donating valued mutual fund shares instead of cash. Tax laws allow you to deduct the full market value of the higher share price without having to claim a taxable gain on the increase in value.
Look at the cost of mutual funds. The disclosure requirements require fund managers to adequately present the costs associated with each mutual fund. All things being equal, you should consider these operating costs when deciding between mutual funds with similar performance in a category.
James Angell is a certified public accountant based in Willits. His office is at 461 S. Main St. and can be reached at 459-4205.