Ways To Reduce Investment Taxes

Mutual funds can be a great way to invest because they have many advantages. However, mutual funds also have a lot of tax complications. Most investors aren't aware of the associated tax issues when they first invest in mutual funds.

But they're important concerns. If taxes are having a significant impact on your mutual fund returns, there are steps you can take to address tax issues. Here's how you can reduce taxes on mutual fund investments.

1Buy Shares Post Ex-Dividend Distribution

Funds pay their capital gains distributions on a specific date. It doesn't matter whether you owned the shares for one day or ten years - you're immediately going to be responsible for tax on the capital gains. This is true even if you didn't own shares in the fund when the gain was realized.

Check and see when the fund makes its distributions. If it's happening soon, wait until the date has passed. Most distributions happen toward the end of the calendar year. That is why the beginning of the year is a great time to purchase mutual funds.

2Take Advantage Of Tax-Deferred Accounts

Like all other things being equal, high yield means high tax. If possible, own these investments in a tax-deferred account. This is where the tax penalty's minimized, and your long-term gains will be the greatest.

Your investments will grow at a much greater rate if you can refrain from pulling money out of them to pay taxes. True, you will have to pay the tax someday. But your nest egg will grow much larger in these accounts.

3Invest In Funds With Lower Turnover Rate

Funds that churn through many investments can create a tax burden on the investor, even if the fund's share price drops. It is almost always true that a fund with fewer turnovers in its investments will result in less tax burden. It is also a sign that a fund has a long-term approach to investing.

4Consider ETFs And Municipal Bonds

Exchange-traded funds (ETFs) usually have a lower tax consequence than actively managed mutual funds. These portfolios tend to be more stable. This is because ETF managers don't have to sell securities to make capital gains distributions.

Moreover, there are mutual funds that are managed to minimize the tax burden incurred by the investor. This is accomplished via municipal bonds, avoiding regular bonds, and utilizing any losses to offset any gains. Funds that specialize in municipal bonds can potentially avoid both state and federal taxes.

5Always Plan Before Selling

Are you considering selling shares in a fund? Anytime you do, consider the tax implication. It would be best if you have the resources available to pay the taxes.

Do this without having to dip into other investments. Make sure that you have the money set aside and available when tax time arrives. Remember that investments held for a minimum of a year are taxed at a lower rate than investments held for less than a year.

There are many ways to minimize the taxes realized with mutual fund ownership. However, taxes are not the only consideration. Sometimes, it is best to sell and lock in your profits rather than hold on to an investment for tax purposes. Always let common sense be your guide.

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