What are capital gains distributions?
Since the New Year is upon us, I thought I would take the time to discuss some year-end topics that will likely affect your investments. This article is the first of two related to these topics. Here I will discuss capital gains distributions, and in the second article I will discuss tax loss harvesting.
So, what are capital gains distributions? Mutual funds buy and sell securities, or investments, throughout the year. When a fund sells a security for more than the purchase price, the fund receives a capital gain. If the fund has owned the security for less than a year, the gain is short-term. If the fund has owned the security for over a year, the gain is classified as long-term. The significance of the holding period affects taxation. Short-term gains are taxed at the same rate as ordinary income. Long-term gains are taxed at a special rate of 15% or 5% for those in the lowest income tax bracket.
A fund is required to distribute these gains annually to their shareholders in order to avoid taxation at the fund level. Most funds distribute capital gains mid to late December. When a fund makes a capital gains distribution, the net asset value (NAV), or share price decreases by an equal amount. For example, if a fund makes a $0.75 gain per share distribution when the NAV is $38.00 then the NAV will drop to $37.25.
In company-sponsored retirement plans, these distributions are reinvested automatically into the respective mutual fund and any taxes due will be deferred. If the mutual funds are held outside of a company-sponsored plan, you have the option to have the distributions reinvested or paid to you directly. Taxes will be due when you file your taxes for any capital gains distributions received in a taxable account, whether reinvested or paid to you directly.
If you have any questions regarding capital gains or if you want to discuss your account, please feel free to contact us by email at info@smart401k.com or by phone at 877-627-8401.
Buck Wendel, Investment Advisor
