Ask Bob: How can I Manage Capital Gains from My Mutual Funds?

Adviser George Padula outlines options for dealing with those pesky mutual fund capital gains.
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Question

I read your article which discussed capital gains. I have a question about my mutual funds and the capital gains taxes that I pay every year.

I have owned shares for many years of American Funds New Perspective Fund. This fund does very well and I have made a lot of money over the years, but for just about every year this fund has a high amount of capital gains which causes me to pay a lot of taxes. I am 72 years old, now retired, and have a lifetime annuity from TIAA-CREF. Do you have any suggestions about how to handle my tax situation to make my taxes lower? These capital gains are hurting me, although I have a comfortable income to live on.

Answer

The New Perspective Fund invests in large-cap growth companies that are global in nature, notes George Padula, CFP®, principal and wealth manager of Modera Wealth Management, LLC. If you look at a list of the top holdings, many of the companies will be familiar to investors.

“The fund typically makes one payout per year consisting of dividends and capital gains based on the sales that the fund managers have generated during the year,” he says. “The payout can vary widely every year and the payout can be substantial even in years when the fund does not perform well.”

He adds, “Since you state you have owned the fund for quite some time, assuming you reinvested dividends, you now own a substantial number of shares. This can lead to some pretty high payouts and high tax bills, as you have discovered.”

The general question is whether or not to own an actively managed mutual fund in a taxable account. Actively managed mutual funds can have these large payouts, making them somewhat tax-inefficient. “Generally, an actively managed fund, with high payouts, are better held in tax-deferred accounts such as an IRA,” Padula says. This “tax location” decision can be summed up as it’s not what you earn, it’s what you keep. Currently, capital gains distributions are taxed at tax rates of 0%, 15%, or 20%, depending on the individual's ordinary income tax rate.

So, what should you do? “There are a few strategies to consider,” says Padula. “First, if you are reinvesting the distributions, you could change this to have them paid out in cash. This will allow you to have cash ready to pay the taxes due. You could then use the remaining cash to buy a more tax-efficient investment such as an exchange-traded fund (ETF) or an index fund.”

“Second, if you have any other holdings that are at losses, you could sell those and offset the distributed capital gains with those losses,” he adds.

“In a similar fashion, you could sell some of the New Perspective Fund,” notes Padula. “Since you have owned the fund for a while with reinvestments, you likely have multiple lots with various cost bases. You could sell only those specific share lots that will have the least gain to aid in your rebalancing. Again, you then use the sale proceeds to buy a more tax-efficient investment.”

“Finally,” says Padula, “if you are charitably inclined, donating shares of the fund either directly to the charity or to a donor-advised fund, is a tax-efficient way to avoid capital gains and potentially get a tax deduction as well.”

In all cases, you should consult with your tax advisor or your investment advisor to determine the appropriate strategy for your specific situation.

Got questions? Get answers!

Email Robert.Powell@maven.io

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Question

I read your article which discussed capital gains. I have a question about my mutual funds and the capital gains taxes that I pay every year.

I have owned shares for many years of American Funds New Perspective Fund. This fund does very well and I have made a lot of money over the years, but for just about every year this fund has a high amount of capital gains which causes me to pay a lot of taxes. I am 72 years old, now retired, and have a lifetime annuity from TIAA-CREF. Do you have any suggestions about how to handle my tax situation to make my taxes lower? These capital gains are hurting me, although I have a comfortable income to live on.

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