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
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:
Mutual Fund Advantages
- History of Mutual Funds
- Dollar Cost Averaging
- General advice about choosing a fund
- Mutual Fund Ratings
- Evaluating Mutual Fund Investment Risk
- Mutual Fund Share Classes
- Mutual Fund Fees
- The Mutual Fund Prospectus
- How important is the manager's length of experience?
- Why is the prospectus hard to understand?
- Mutual Fund Annual Report
- Comparing your fund to the competition
- Comparing funds on an after-tax basis
- Average Return on Investment
- How Not to Pick a Mutual Fund
- Cashing in Your Fund
- When to Sell Your Fund
- Mutual Funds and Asset Allocation
- When to get started with a mutual fund
- Types of Mutual Funds
- Value Stock Funds
- Growth Stock Funds
- Small and Micro-cap Stocks
- Mid Cap
- Large Cap Companies
- Income Stock Funds
- Mutual Fund Index
- Enhanced Index Funds
- Sector Mutual Funds
- Stock Market Sectors
- Defensive Stocks
- International Funds
- Real Estate Mutual Funds
- Socially Responsible Funds
- Balanced Funds
- Tax-Efficient Funds
- Bond Convertible Funds
- Junk Bond Funds
- Mixtures of stock types
- Closed End Funds
- Exchange Traded Funds (ETF’s)
- Stock Picking Strategy - Picking your own stocks?
- Fund names, and what they really invest in
- How to get started
- Where can I start investing with no money?
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