Higher Returns Means Potential For Higher Taxescornerstonews
Capital Gains Distributions and the Effect on Your Accounts
The holidays are around the corner which means capital gain distributions are as well. We want to share with you two important issues that might affect you and your accounts so you can be prepared.
What is a capital gain distribution?
A capital gain distribution is a payment by a mutual fund of a portion of the proceeds from the fund’s sales of stocks and other assets from within its portfolio. It is the investor’s pro-rata share of the proceeds from the fund’s transactions. Mutual funds are required by law to make regular capital gains distributions to their shareholders.
What does this mean for my account?
Your account might look wonky for one to three days. As these distributions take place you could see a drastic reduction in price of the fund in one day (showing negative performance not related to the market). Then, in the next day or two you will see a proportionate increase in the number of shares you own making this a neutral event in your account. Given the growth we have seen in the last couple of years, this year’s distributions will most likely be higher than what we are used to. If you see a change in one or multiple positions in your account that does not line up with the market over the coming weeks, this is most likely due to the capital gains distributions taking place.
Be prepared for bigger gains and corresponding potential tax liability.
Gains are larger this year than the last couple of years because gains are slowly released as mutual funds make internal trades to rebalance and improve their allocation. So, although last year showed bigger percentage increases in accounts, much of the taxable gain was not released and we are seeing more of that this year. The tax liability issue only matters for nonretirement accounts as qualified retirement accounts do not recognize gains, but they may still fluctuate in value during this time period.
Is this good news or bad news?
Probably both. The good news is that, overall, our accounts have performed very well, and the capital gains distributions are a product of the performance —that is the good news. The bad news is that the capital gains distributions will likely increase the tax liability for our clients that have non-retirement accounts. The other consideration is that the distribution of capital gains also increases the tax basis in the position. This means that we are stepping up the tax basis now at historically low capital gains rates, which might be a good thing if tax rates go up in the future. We just didn’t want you to be caught off guard.
As always, feel free to call the office if you have any questions. Hope you all have a safe and wonderful holiday season.
The Cornerstone Team
*This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.