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Mutual Fund Taxes Alleviation

When the end of the year knocks at our door we should start thinking of the taxes we must pay. No matter how annoying you find tax planning, it is better to start thinking about it earlier in order not to lose money later.

Mutual funds are susceptible to taxes, so start planning how you can alleviate the tax burden in advance.

Consider the following example, which provides an illustration of how you can get hurt if you don't plan in advance. Imagine that in 2004 you invested $10, 000 in mutual fund X. At the end of the year you still own this mutual fund. Unfortunately, its value has dropped to $8,000. Despite the fact that you haven't sold the fund, your mutual fund company will still apply distributions that are taxable events.

It is obvious that you have experienced the so called unrealized loss since you have not acquired any gains. However, you are still subject to taxes. Depending on the structure of the mutual fund, a different amount of taxes will be levied. Generally, if the mutual fund has had a low turnover during the year, it will distribute smaller amounts to its shareholders. Additionally, higher amounts will be distributed if the mutual fund has experienced a greater turnover.

Valuable Advices

Here are some advices that provide a possibility of alleviating the potential tax burden on your mutual fund investment.

  1. After distribution investment

    Mutual fund distributions are normally paid in December. Therefore, try not to purchase shares of a mutual fund right before it is about to pay the distributions to its shareholders. You should do this in order to eliminate the possibility of being charged a tax on gains you haven't yet enjoyed. It is always useful to first address your broker or mutual fund company for the exact distribution date and the amounts that are to be distributed among the shareholders.

  2. Put in your income that is non-taxable

    Although you will still be subject to taxes on the capital gains acquired, investing tax-exempt income in a municipal bond funds will free you from the responsibility of paying federal taxes. Additionally, some mini funds are exempt from state and local taxes.

  3. Increase the number of tax-deferred investments in your portfolio

    Both IRA and 401 (k) plans represent tax-deferred investments. By pouring more money in them you will substantially alleviate your tax burden. Another option to minimize the taxes you should pay is the Roth IRAs. You are not charged any taxes when taking money out of the account. At the same time investment growth is exempt of taxes, despite the fact that taxes are levied on annual contributions.

  4. Long-term investments are preferred

    If you are too impatient and sell your mutual fund before one year has passed, taxes will be levied on the acquired capital gains. Like in stocks, the more you own the mutual fund, the less the tax gets. 

  5. Don't "time the market"

    Trying to make predictions about the movement of the market may end you up in a losing position. Don't try to chase the market by moving from one mutual fund to another, since you will increase your expenses by facing additional transaction costs. Furthermore, you risk losing the market gains. Have a long term perspective on your investments if you want to alleviate the tax burden and enjoy more gains on your investment.

Planning your tax strategy beforehand may be crucial to the results of your investment portfolio. So, be wise and don't leave it for the last days of the year, when it may be too late to undertake any actions.

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