Congress can help long-term mutual fund investors keep more of their money working

Mutual funds are still one of the easiest and most practical ways for people to build long-term financial security. Families saving outside of workplace retirement plans, retirees managing taxable assets and everyday investors who want diversification all rely on them.

That is why we support the GROWTH Act and are asking Congress to pass it.

The bill would help long-term mutual fund investors avoid surprise tax bills on automatically reinvested capital gains until they actually sell their shares. Importantly, investors would still pay the taxes they owe. The only difference is that they would pay when they sell their shares, not while they are still invested and reinvesting gains.

This is a straightforward change that addresses a basic question of fairness.

In many cases, these investors are doing exactly what wealth management experts advise savers do – they are saving regularly, staying invested and using accessible investment products to prepare for the future. But under current tax rules, these investors can still receive tax bills even if they have not sold any shares.

Financial advisors, of course, know why this happens. When a mutual fund manager sells investments inside the fund, it can create capital gains and the fund manager reinvests the gains in the mutual fund. However, the IRS currently recognizes the capital gains as taxable, leaving the investor with a surprise tax bill when they personally haven’t sold any of their investments.

To be sure, investors generally understand that selling an appreciated security creates a tax bill. They made the decision to sell, realize the gain and take the proceeds. But mutual fund investors can face a tax bill even when they do none of those things. They stayed invested, reinvested the distribution and never took money out of the account.

Granted, in any one year, the drag may seem small. It may be 15 basis points here, a few additional dollars there or a tax bill that does not appear dramatic in isolation. But American savers feel that impact. Long-term investing is built on compounding, and money used to pay taxes is money that is no longer invested and working for the investor.

And in a fund that grows in value over many years, the difference could be tens of thousands of dollars, and potentially more for investors with larger taxable accounts. For families saving for retirement, education, a first home or greater financial security, that is significant.

The GROWTH Act would address that mismatch by recognizing the difference between an investor who chooses to realize a gain and an investor who is simply staying invested, reinvesting distributions and trying to build financial security over time.

Financial advisors see how these rules affect people because they work with individuals and families in communities across the country every day. They see clients who are saving responsibly, managing taxable accounts and trying to make good long-term choices, only to be surprised by taxes on gains they did not personally choose to realize.

Public policy should make it easier for Americans to invest, build wealth and retire with confidence. Passing the GROWTH Act would be a meaningful step toward a fairer system for long-term mutual fund investors.


Dale E. Brown is president and CEO of the Financial Services Institute.