Avoiding sticker shock from mutual fund capital gain distributions

If you invest in a mutual fund outside an IRA or retirement plan, the fund periodically distributes taxable capital gains. And even though you haven't sold a share of your investment, you're liable for taxes on those gains.

"Capital gain distributions from many mutual funds have increased from prior years because of several strong performance years for equities, and some investors are being surprised by the associated increase in taxes owed," says Robert Fishbein, a vice president in Prudential's Tax Department.

Fishbein identifies three strategies that may help reduce tax liability associated with mutual fund capital gain distributions. "First, maximize tax-favored assets, like traditional and Roth IRAs, because they are not affected by capital gain distributions," he explains. "You can do so by selling your taxable mutual fund and making an IRA or Roth IRA contribution with the proceeds."

A second option is to transfer traditional IRA assets to a Roth IRA and pay any tax liability by selling your taxable mutual funds. "In effect," says Fishbein, "you'll be eliminating some or all of the asset generating the troublesome capital gain distribution."

A third strategy is to reduce or eliminate future capital gain distributions by selling the fund that is generating the gain. "You can replace that fund with a 'tax-efficient' mutual fund designed to minimize internal trading or purchase stocks directly," he says. "Direct stock investments do not cause capital gain distributions."

Please consult with your tax and legal advisors regarding your personal circumstances.

Want more information? Read Fishbein's bylined article in LifeHealthPRO. Want to speak with Robert? Contact Lisa Bennett.

The Prudential Insurance Company of America and its affiliates Newark, NJ.

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