Mutual Funds Distribute Capital Gains: What You Need to Know

Mutual funds distribute capital gains to investors, and it's essential to understand how this process works.

The IRS requires mutual funds to distribute capital gains to shareholders by December 31st of each year.

You might receive a 1099 form from your mutual fund company, showing the amount of capital gains distributed to you.

This distribution can be a surprise, especially if you're not expecting it.

Mutual funds are a type of investment vehicle that pools money from many investors to invest in a variety of assets.

They're typically managed by a professional fund manager who makes investment decisions on behalf of the investors.

Mutual funds have capital gains just like we do as individual investors, and they're required to pass at least 95% of their net gains to investors.

These gains can come from selling securities at a profit, such as stocks or bonds.

Many of us assume that all capital gains are a good thing, but that's not always the case. If a mutual fund produces capital gains, it's true that gains are better than losses, but there's a taxability caveat to consider.

You'll owe taxes on gains you didn't even get to enjoy if you purchased the fund after the appreciation occurred. For example, if you bought a fund that had already appreciated due to its successful investment in JP Morgan, you'd owe taxes on those gains even if you didn't benefit from them.

You have two options when a fund distributes a taxable capital gain: dump it before receiving the distribution or bite the bullet and hang onto the fund. If you have a sizable unrealized gain in the fund, selling it would trigger a tax on that gain, making the first option more appealing.

Consider this example: if you own 100 shares of a $100 fund with a $57 distribution coming up, and you've held the fund for only a short time, it might be better to sell it before receiving the distribution to avoid paying taxes on the gain.

However, if you've held the fund for several years, you may have a large unrealized gain, and taking the distribution might be the better option.

You can also use an unrealized loss to offset your income. If you hold a mutual fund at a loss that's about to distribute a capital gain, it could be a great opportunity to sell the fund and harvest the loss.

Here are some key tax implications to consider:

It's worth noting that capital gains distributions can occur even if the fund itself has lost value. Portfolio managers try to balance tax with investment considerations when trading securities, but this is not always possible.

In recent years, taxable investors have faced a trend of increasing capital gains distributions. According to data since 2008, the average U.S. equity fund distributed 11% of its net asset value (NAV) as a taxable distribution in 2018. This means that, on average, taxable investors would have owed tax on $11 of their investment, even if they chose to automatically reinvest the distribution.

As you head into the fall and winter, be on the lookout for capital gains distributions and consider the tax implications of your investments.

Capital gains distributions can be a confusing and costly aspect of investing in mutual funds. You might assume that all capital gains are a good thing, but the taxability of those distributions can significantly impact your net returns.

A fund's distributions are taxed regardless of their character, and some capital gains distributions stem from successful investments and appreciation that occurred before you purchased the fund. If you purchased the fund from our example back in 2009 or earlier, you'd have enjoyed the fund's appreciation resulting from its successful investment in JP Morgan.

You have two options when dealing with a fund about to drop a big taxable distribution: dump it before receiving the distribution or bite the bullet and pay the tax. If you have a sizable unrealized gain in the fund itself, you'll owe tax on that gain if you decide to sell.

Here's a summary of the key dates to keep in mind:

If you elect to have your distributions automatically reinvested, you'll still be left with the big tax bill for the distribution.

The Record Date is a crucial date to keep in mind when it comes to capital gains distribution. This is the date on which the fund sells shares and makes a per-share distribution to all shareholders as of that date.

Voya Funds' Record Dates vary, so it's essential to check the Capital Gain Distributions page to find the specific date for the fund you're invested in.

To receive a distribution, you must own the fund on the Record Date. Conversely, if you want to avoid a distribution, you need to be out of the fund on that date.

It's worth noting that Voya Funds generally doesn't recommend making investment decisions around capital gain distribution dates, so it's always a good idea to consult with your tax advisor about your individual situation.

The Ex-Date is a crucial step in the capital gains distribution process. It occurs shortly after the Record Date, typically the next trading day.

On the Ex-Date, the dollar amount of the fund's capital gains distribution is temporarily taken out of the fund's assets. This results in a drop in the fund's daily share price, also known as the NAV.

Market activity contributes to the final share price, but the Ex-Date brings an additional "hit" to the share price of the fund.

Taxable investors have had a tough time in recent years, with capital gains distributions taking a significant chunk out of their investments. In 2018, the average U.S. equity fund distributed 11% of its net asset value (NAV) as a taxable distribution, resulting in an average tax bill of $11 for a taxable investor with a $100 investment.

Every year since 2008, there have been average distributions, with the red line representing U.S. equity funds' average distribution as a percent of NAV never dipping below zero. This means that taxable investors have had to deal with capital gains distributions, regardless of how the market has performed.

For a taxable investor, it's essential to be aware of these distributions and plan accordingly. By tracking capital gains estimates and being prepared for the tax implications, investors can minimize the impact of these distributions on their overall returns.

Automatic reinvestment can be a convenient option for investors who don't want to manually reinvest their distributions.

This method can save you time and effort, as it automatically uses your distributions to buy more shares of the fund.

However, it doesn't eliminate the tax implications, so you'll still have to deal with the tax bill for your distributions.

In our example, if you elected to have your distributions reinvested, you'd end up with an extra 132.558 shares, bringing your total position to 232.558 shares.

At a net asset value of $43, 232.558 shares would be worth exactly $10,000.

Capital gains distributions can be a real tax hit, especially if you're not prepared. Many of us assume that all capital gains are a good thing, but that's not always the case. In fact, some capital gains distributions can stem from successful investments and appreciation that occurred before you even purchased the fund, leaving you with a tax bill for gains you didn't even get to enjoy.

If you're facing a big fat taxable distribution, you've got two options: dump the fund before receiving the distribution or bite the bullet and hang onto it, paying the tax. But before making a decision, you need to consider the tax implications of selling the fund versus hanging onto it. If you've got a sizable unrealized gain in the fund itself, you'll owe tax on that gain if you decide to sell.

The payable date is usually within three business days of the record date, and that's when the fund's capital gains distribution is returned to shareholders. If you elect to have your distributions reinvested, new shares are purchased in your account as of the lower price on the ex-date. But even with automatic reinvestment, you're not insulated from the tax implications.

Here are some key facts to keep in mind:

It's essential to be aware of the capital gains distribution trend, especially as you head into the fall and winter. By understanding how capital gains distributions work and the tax implications involved, you can make informed decisions about your investments and minimize the tax hit.

Capital gains are a normal part of mutual fund investing, and they can be a good thing. However, they're also taxable, which can reduce your net returns.

Most investors assume that capital gains are always a good thing, but that's not entirely true. While gains are better than losses, there's a catch - you'll owe taxes on gains you didn't even get to enjoy. If a mutual fund sells a security at a gain, that gain is taxable, even if you didn't sell the fund yourself.

Long-term capital gains, which occur when a fund holds a security for 12 months or longer, are taxed at a more favorable rate of 15% for individuals in tax brackets higher than 15%.

Capital gains are often assumed to be a good thing, but there's a catch. Distributions from a mutual fund directly reduce that fund's net asset value, regardless of their character.

Gains are indeed better than losses, but some capital gains distributions stem from successful investments that occurred before you purchased the fund, and you'd owe taxes on gains you didn't even get to enjoy.

If you purchased a fund from 2009 or earlier, you'd have enjoyed the fund's appreciation resulting from its successful investment in JP Morgan, and receiving the taxable distribution might not be so bad.

Short-term capital gains are taxed at the investor's own Federal Tax Rate, the same as dividend income, wages, and other ordinary income.

Long-term capital gains, on the other hand, are taxed at a more favorable rate, specifically 15% for individuals in tax brackets higher than 15%.

Investors who sell shares must determine whether the gain (or portion of the gain) is short- or long-term based on their own records.

Mutual funds have capital gains just like individual investors, and any gain from selling a security is taxable.

Capital gains distributions can occur even in a declining fund, which might seem counterintuitive.

Funds are required by law to report capital gains generated on a holding, even if the fund itself has lost value. This means investors may receive large capital gains distributions, despite the fund's decline in value.

Portfolio managers try to balance tax with investment considerations when trading securities, but this is not always possible, nor desirable from a total return standpoint.

As a result, investors may receive capital gains distributions from a fund that has declined in value, which can be a surprise.