Tax and distributions

Most investors would agree that mutual funds are a great way to help create a nest egg, save for retirement or for your kids’ college education. There are, however, an entire series of taxes that are levied against investments of all kinds, including mutual fund investments. While they may not always seem fair, they are a fact of life and the more you know about all the various forms of taxes, the better prepared you’ll be to deal with them.

While there are fees associated with some mutual funds when you open the account, and taxes for capital gains as the money appreciates within the mutual fund, there are also a series of taxes associated with the distribution of earnings from the mutual fund back to you. These distributions can take on several different forms, such as capital gains, income dividends and interest. A mutual fund is legally obligated to give out all of the investors income and the money that the fund made. But what exactly is an income dividend?

Income dividends usually include dividends, capital gains and interest that is earned by the mutual fund company minus the expenses and fees are taken out. The distribution associated with capital gains is usually made once per year to the shareholders. These capital gains come from a year of good performance by the mutual fund. When a mutual fund company pays out dividends to their shareholders, the NAV or net asset value of your mutual fund will go down, but you can also take that dividend pay out and buy more shares if you’re happy with the performance.

There are ways to help avoid the tax liability of reinvesting your dividends back into your mutual fund. Most distributions done by mutual fund companies is done near the end of the year. If you don’t want to spend the payout on Christmas presents, you can reinvest the money, but you should do it after the record date. This will help you avoid extra tax liability on your dividends.

Paying taxes on your distribution is a pain. But if your mutual fund is performing well, a small tax on your earning won’t hurt so bad. This is another reason why intelligent, well managed investing is so important. Not only do you have to worry about your fund going up and down in price, but also tax liability. That’s why it pays to invest wisely and use a disciplined approach.