Tax-Efficient Funds

Obviously, funds with the words “tax-managed” in their names should be tax-efficient. But many funds with a low turnover rate of their holdings also achieve a low current tax liability for the fund holders.

Tax-efficient strategies include selling the highest-cost stocks first to limit the tax hit, and try to hang onto stocks for more than one year to get the lower capital gains tax rate. They also sell losers to offset the profit on gains.

Take advantage of them in a standard investment account, never in a tax-deferred IRA or 401k. There will be little tax to pay anyway.

Successful tax-efficient funds include the Calamos Growth Fund (5 year total tax hit of only 4.63%) and the Vanguard Tax-Managed Capital Appreciation (only .24% to pay taxes on over 5 years).

Here is an example of tax-efficiency:

Suppose you put $10,000 into a bond fund that yields 6% a year or $600. If you are in the 31% tax bracket, you will pay $186 in taxes.
 
If you were to put $10,000 into a stock fund that paid out 6% in capital gains this year, you would pay $120 in taxes since the $600 would be taxed at 20%.
 
If your $10,000 was invested in an index fund, which would have almost no distributions, and gained 6% in value this year, you could sell $600 worth of your shares of which only $36 (6%) is a taxable gain (as long as you've owned the fund for at least one year), the other $564 being a non-taxable withdrawal of principal. You would only owe $7.20 in taxes on the $600! There would also be some tax on any distribution of dividends.

Any money that is in your mutual fund upon your death will not be subject to any income tax - nothing. Your heirs will assume the shares with a new cost basis "stepped up" to the share value on the day that you die. Note that variable annuities do not qualify for a tax-free stepped up basis for your heirs.

Speaking of taxes, when you sell your fund shares, be sure not to pay taxes on reinvested gains and dividends twice. Only the gains from the current year will be taxable, since you should have paid the prior year’s gains already.

Other Stock Market Basics Topics:

1. Mutual Fund Advantages
2. History of Mutual Funds
3. NAV
4. Dollar Cost Averaging
5. General advice about choosing a fund
6. Mutual Fund Ratings
7. Evaluating Mutual Fund Investment Risk
8. Mutual Fund Share Classes
9. Mutual Fund Fees
10. The Mutual Fund Prospectus
11. How important is the manager's length of experience?
12. Why is the prospectus hard to understand?
13. Mutual Fund Annual Report
14. Comparing your fund to the competition
15. Comparing funds on an after-tax basis
16. Average Return on Investment
17. How Not to Pick a Mutual Fund
18. Cashing in Your Fund
19. When to Sell Your Fund
20. Mutual Funds and Asset Allocation
21. When to get started with a mutual fund
22. Types of Mutual Funds
23. Value Stock Funds
24. Growth Stock Funds
25. Small and Micro-cap Stocks
26. Mid Cap
27. Large Cap Companies
28. Income Stock Funds
29. Mutual Fund Index
30. Enhanced Index Funds
31. Sector Mutual Funds
32. Stock Market Sectors
33. Defensive Stocks
34. International Funds
35. Real Estate Mutual Funds
36. Socially Responsible Funds
37. Balanced Funds
38. Tax-Efficient Funds
39. Bond Convertible Funds
40. Junk Bond Funds
41. Mixtures of stock types
42. Closed End Funds
43. Exchange Traded Funds (ETF’s)
44. Stock Picking Strategy - Picking your own stocks?
45. Fund names, and what they really invest in
46. How to get started
47. Where can I start investing with no money?
    

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