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Mutual Funds Can Mean Extra Taxes

mutual funds mean extra taxes
Key Points
  • Many stock mutual funds can create unnecessary taxes when mutual funds are not held within a tax-favored account.
  • It can be helpful to compare a mutual fund’s tax adjusted return ranking relative to other funds in the same category.
  • To minimize the potential tax burden on investment portfolios, it is worth considering a tax-favored work retirement plan such as a 401k plan or IRA plan

In the normal course of events, investors purchase stocks in anticipation of dividends and future gains. Late-year incomes from mutual funds may feel like a welcome bump to income as the year winds down. There are many potential tax benefits associated with well-managed portfolios, but there can be drawbacks as well, especially if the portfolio is not properly diversified. And many stock mutual funds can create unnecessary taxes when mutual funds are not held within a tax-favored account. Reducing or eliminating taxes can be one of the best ways to save money while increasing your net investment returns.

Minimizing Extra Taxes with Mutual Fund Investments

When trying to diversify, many investors will purchase mutual funds. Mutual funds are a compilation of stocks – and when you purchase it can make all the difference between being hit with a tax bill or not. You may inherit the gains already inherent in the fund, or you could owe taxes if it was sold after you purchased it. It can be helpful to compare a mutual fund’s tax adjusted return ranking relative to other funds in the same category. Gains from stocks held longer than 12 months are called long-term capital gains. Selling mutual funds in a tax-deferred account, i.e. an IRA or 401k, will not generate capital gains taxes.

To minimize the potential tax burden on investment portfolios, it is worth considering a tax-favored work retirement plan such as a 401k plan or IRA plan. This can be especially beneficial if there are specific funds that are not tax-efficient in which investment wants to be made. Additional options to explore include owning a diversified stock portfolio that is managed in a way sensitive to potential tax pitfalls.

Mutual Fund Investments with an IRA

Within an IRA, transactions made are not taxable, and this can provide a benefit for mutual fund owners using an IRA for purchases and sales. Mutual fund exchanges are also not taxable, as long as the money is being exchanged into a registered IRA account. In a Roth IRA, contributions are made using post-tax dollars from the beginning, which allows for withdrawals to be tax-free providing certain conditions are met. Besides mutual funds, IRAs can hold stocks, bonds, and cash, meaning diversification can be achieved with proper planning and guidance.

Minimize Tax with a Self-Directed IRA

A Self Directed IRA offers greater freedom than an IRA from a traditional brokerage house. This means there is no bank advising against purchases. SD IRA holders can invest in stocks, bonds, and mutual funds, in addition to more traditional offerings. Municipal bonds can add additional income and may be tax-free at a state level, as many states do not tax on their own bond income.

Consider buying mutual funds and avoiding capital gains taxes as an additional bonus to your Self Directed IRA or Solo 401k. As always, it is vital to avoid prohibited transactions whether you invest in an IRA or a 401k. It makes the most sense to get professional guidance when setting up any accounts where money will be placed. This will prevent errors from creeping in, and will avoid breaking rules by ensuring guidelines are followed. It is always worth having more information rather than less, as this helps investors make the best decisions for themselves, their money, and their portfolio.

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