Investors, take note: Not only are the financial markets treacherous right now but the tax bite is rising on mutual funds.
In fact, investors paid out record taxes on their mutual funds in 2007 despite a sluggish stock market, according to a study by research firm Lipper.
“Using very conservative assumptions, we estimate buy-and-hold, taxable mutual fund investors surrendered a record-setting $33.8 billion in taxes to Uncle Sam, easily surpassing 2000’s record amount of $31.3 billion,” wrote Tom Roseen, a senior research analyst in Lipper’s Denver office.
Fund companies distributed $582 billion to investors last year, breaking the prior record of $419 billion, according to the study. Those figures reflect both capital gains and income dividends from stock and fixed-income funds.
Payments were made to investors who held shares in unsheltered accounts and those using Individual Retirement Accounts, 401(k) plans and the like. Of the $12 trillion in mutual funds, roughly half were held in taxable accounts.
In unsheltered accounts, Roseen estimated taxes clipped returns by 1.3 to 2.2 percentage points annually. He projects the bite could get worse in future years if tax rates rise as widely expected.
Then again, investors don’t have to accept large tax bills, even when the financial markets are humming. Fund shareholders can defer or avoid much of the bite with tax-sheltered accounts, especially Roth IRAs, on which tax-free withdrawals normally apply.
Another option: tax-efficient funds. They limit the tax damage by realizing portfolio losses, deferring taxable gains, using tax-free municipal bonds and taking other steps.
In the meantime, Roseen hopes to see more attention paid by fund companies and investors to measuring results on an after-tax basis, and he recommends federal legislation that would let investors defer the tax bite on capital gains until they sell their holdings.
– Researcher Morningstar Inc. cites Section-529 college-saving plans from Ohio, New York and Nebraska, plus two from Mississippi, as the worst five in the nation in terms of high fees, poor diversification, low flexibility and so on.
Section-529 plans are tax-sheltered programs, named after a portion of the Internal Revenue Code, that let parents and others save for a child’s education. Nearly all states offer a 529 plan, typically in conjunction with one or more mutual-fund firms. The plans tend to be highly flexible, with low minimum-investment floors and high investment ceilings.
There’s no federal tax deduction on 529 contributions, but most states offer one.
Morningstar lists only those plans that it considers the five best and five worst.
This year’s best plans consist of Maryland’s 529 program run by T. Rowe Price, Colorado’s plan with Legg Mason, Illinois’ Bright Start program with OppenheimerFunds and two Virginia programs.
– If you land a new job, don’t be surprised if your company automatically signs you up for its 401(k) retirement plan.
The Pension Protection Act of 2006 gave a green light to automatic enrollment and more employers are doing it, according to a survey by Hewitt Associates. Some 44 percent of firms responding to the survey enroll new hires automatically, up from 36 percent in 2007 and 24 percent in 2006.
Other automatic-investing features also are gaining steam for 401(k) accounts, including enrolling existing workers, rebalancing worker investment accounts for them and boosting worker contributions annually.
Employees have the right to opt out of these programs but many don’t. The same apathy that prevents people from signing up for the plans keeps many from dropping out, too.
