Higher taxes loom for fund investors

Advisers recommend planning now as strong market performance could raise capital gains distributions

Nov 24, 2014 @ 1:06 pm

By Trevor Hunnicutt

A rising tide may lift all ships, but beware the tax bill.

Financial advisers doing end-of-the-year planning for clients must begin the work of reconciling the gains of the U.S. economy and financial markets with the capital gains that could increase those clients' tax liabilities.

“It's been five-plus years of success in the market,” said Bradley A. Weber, a certified public accountant and principal at Aspiriant. “Every investor should expect capital gains distributions."

In some cases, the distributions can be high. For instance, the Neuberger Berman Large Cap Discipline Growth Fund (NBCIX) faces estimated short and long-term gains totaling about 54% of the fund's net asset value.

Alexander Samuelson, a spokesman for Neuberger Berman, declined to comment.

There are many factors contributing to funds' tax liability. One investment strategy may involve frequent trading — incurring taxes for short-term gains in the process — while in other cases, a fund working to meet redemptions may be forced to sell securities that have reported a gain.

The fact of a funds' high tax liability doesn't make it — in and of itself — a poorly managed fund, according to advisers. In fact, it may depict a manager who cycled out of an overvalued market and into another asset class that improved performance for the investor.

For a number of funds, an important milestone is coming up within the next few weeks before the end of the year. That's the ex-dividend date. Often, dividends or capital gains are deducted from the share price in early December.

Investors who purchase funds before distributions face tax liability on those distributions. The funds figure out which investors are entitled to receive the distributions as of another milestone, called the record date.

"Buying shares just before to the ex-dividend date is often referred to as 'buying the dividend,' and it's something we avoid whenever possible for our clients,” advisory firm Adviser Investments said in a newsletter last week. Those dates and estimated distributions are often available directly from the fund company itself, on their website. One database that gathers the data together is CapGainsValet.com.

Though not always the case, exchange-traded funds are generally thought to be more tax efficient in part because managers are less likely to redeem securities for cash and many track indices with low turnover.

For his part, Mr. Weber, the Minneapolis adviser, is recommending some clients offset gains with losses from international and commodities funds, which have done relatively poorly. That strategy is known as tax-loss harvesting."

Doing so can spare them a short-term gains liability that, combining state and federal taxes, can reach 50% of the gain.

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