Tax alert: Signs point to an increase in mutual fund
distributions this year from last year. That could mean higher
taxes for funds held outside of tax-deferred accounts.
But the signals are very preliminary, something akin to
predicting World Series opponents based on division standings at
the end of April. You'll know for sure when you get your 1099
statements from your fund companies early next year.
One harbinger: Combined dividend and capital gain payouts by
funds in this year's second quarter totaled $53.9 billion vs.
$53.2 billion for Q2 2012, according to the Investment Company
Institute. Q1 distributions totaled $38 billion vs. $34.8 billion
in Q1 last year.
"We just provided our shareholders with estimates as of Sept.
30," said Paul Krug, senior tax manager for T. Rowe Price. "We
see basically the same number of funds that paid last year paying
this year. That's about two-thirds of our equity funds."
In terms of distributions in dollars, Krug now expects an
increase. "Of the funds that existed last year and still exist
this year, I'm seeing average estimated distributions up almost
25% over last year," he said. "That's a projection for the year,
based on per-share estimates. And it's only based on capital
gains, no dividends."
Vanguard Group says it can't project its distribution trend
until after Oct. 31. But Joel Dickson, a Vanguard principal and
senior investment strategist, would not be surprised if
distributions are up.
"We've had a nice big run-up in the equity market, and active
managers are not known for tax-efficient practices," he said.
In addition, high turnover by active managers has eaten
through most if not all of the remaining loss carry-forwards that
funds had from the 2008-09 downturn, Dickson says.
Early signs point to a slight decline in dividends, Krug
If dividends do decline, it could be because many companies
accelerated dividends into 2012 in anticipation of higher tax
rates in 2013.
Fund families tend to make more detailed distribution
forecasts starting in mid-November.
On the fixed-income side, Dickson guesstimates that capital
gains will be lower. If true, that would likely be a result of
this year's investor retreat from many bonds and bond funds.
If overall distributions do rise for 2013, it would be the
fourth straight year with an increase.
Last year's distributions totaled $317.32 billion. That was
the fifth highest total since 1986, when the ICI began to track
this data. The peak year was 2007, when funds distributed $594.72
Dividends account for 60% of distributions on average. Capital
gains tend to exceed dividends only in years when the stock
market rises rapidly. Whatever the scope of distributions turns
out to be in 2013, strategists concur that shareholders should
not let the tax tail wag the investment dog.
"At the end of the day, we talk with investors about not
getting focused on distributions," Dickson said. "These things
matter, but ultimately an investor should focus on the after-tax
return of his investment, not necessarily the amount of tax they
Shareholders can minimize the impact of taxes by holding
securities that tend to make higher-tax distributions in
tax-deferred accounts, he adds.
"We see the majority of our investors hold tax-inefficient
vehicles like REITs, high-turnover equity funds, taxable
fixed-income and specialty funds that might have high
distributions in tax-deferred accounts," Dickson said. "That way,
their after-tax return is not affected."