juliamorris4

· 26 Jun 2020

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How much tax do you pay on mutual fund withdrawals?

Taxes on fund profits are often an unpleasant surprise. Ask your adviser about tax consequences before selling shares #moneymatters .

You'll owe taxes on fund profits every year, whether you sell shares or not, unless you own the fund in a tax-deferred account like an IRA or a 401 (k) plan. Mutual funds pass their annual earnings to their shareholders. You must pay taxes on these distributions, even ifyou automatically reinvest them in additional fund shares.

And of course, when you sell mutual fund shares, you'll owe taxes on any profit over your Original cost. Your profit when you sell shares you've owned for 12 months or less is taxable at ordinary income tax rates. Your profit on shares that you sold after January 1, 1998, and owned for more than twelve months is taxable as a long-term capital gain at a top rate of 20 percent. If your ordinary income tax rate is 15 percent, your long-term capital gains rate on assets held more than 12 months is 10 percent https://pesoassist.ph/housing-loans/.

Starting in 2001, profit on shares bought after 2000 and owned for more than five years will be taxable at a top rate of 18 percent. If your ordinary income tax rate is 15 percent, your profit on these shares will be taxed at 8 percent.

Just to make your life more complicated, the federal government isn't the only entity taxing capital gains. The states impose capital gains taxes, too and some states don't define long-term and short-term gains the same way as the federal government. (This is why you have a tax adviser.)

When you sell shares, you owe taxes on the difference between your original purchase price (known in tax jargon as your cost basis) and the sale proceeds. Let's say you originally invested $1,000, and over time you reinvested an additional $800 in dividends. Then you sell the entire fund for $2,000. What's your profit?

If you think it's $1,000 the $2,000 sale price minus your initial $1,000 investment you're wrong. Your true cost includes that $800 of reinvested dividends as well as the $1,000 initial investment. Your taxable profit is only $200-$2,000 minus $1,800.

If you sell all your shares at once, you're taxed on the difference between your total investment and the sale proceeds. But what ifyou sell only some ofyour shares? What with periodic purchases and reinvested dividends, you've bought shares at many different prices. What's the original cost of the shares you're selling?

The IRS currently gives you two basic ways to answer this question: You can assume you're selling shares in the order you bought them, using the chronological cost basis recorded in your statements; or you can calculate an average cost per share, regardless of when they were purchased.

For mind-numbing detail on how to do these calculations, read Internal Revenue publication 564, Mutual Fund Distributions. Alternatively, hand your year-end fund statements to your tax accountant and pay him or her to do the calculation for you. (If you're lucky, the mutual fund company will do it for you. Some big fund companies automatically run these calculations for shareholders every year.)

Ways to minimize mutual fund tax trauma:

Don't write checks on your mutual fund accounts.

Every time you write a check, you sell shares and realize a gain or a loss you'll have to report on your tax return. If you want to tap your funds for income, take the distributions in cash instead of reinvesting them.

Don't trade a lot in a taxable account.

Switching money from one mutual fund to another is as easy as picking up the phone but every switch is a taxable transaction.

Don't buy a mutual fund for a taxable account in November or December before finding out the date on which it distributes its annual capital gains to shareholders.

If you buy the day before, as a shareholder of record you're immediately presented with a tax bill. Say you buy 2,000 shares at $10 each. The fund declares a $1 per share dividend the next day. The official share price drops to $9 and the extra $1 per share is considered a taxable distribution. You owe taxes on $2,000, whether you leave it in the fund or not.

Do sell all your shares in a fund at one time instead of in stages if they're in a taxable account. If you're a retiree and need to sell shares regularly for income, do it once a year and put the proceeds in a money market fund. You can write checks on a money market account without incurring any capital gain or loss because money market funds maintain a stable $1 per share value.