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What Is It?

One way to minimize your income tax liability is to delay purchasing mutual fund shares until after the date dividends or capital gains are distributed to shareholders. If you purchase mutual fund shares just before a distribution is made, the total value of your investment will remain the same, but your current year tax liability may increase.

Here's why. Just before a mutual fund makes a distribution, the share price includes the amount of dividend or capital gain that is about to be distributed. Once the amount is distributed, the price of your shares is reduced by the amount of the distribution to you divided by the number of shares you owned before the distribution. Whether you reinvest the dividend or capital gain or receive it in cash, the value of your investment (including cash) remains the same. However, you may owe current taxes on the amount of the distribution. The following example illustrates this strategy:

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Example(s): Margaret had $1,400 to invest and purchased 100 shares in a mutual fund one day before the fund was set to distribute dividends. The cost per share was $14. The next day, the fund distributed $1 per share, which Margaret reinvested. Because the share price was then only $13 per share (due to the distribution, assuming market factors remained neutral), she was able to purchase approximately 7.692 additional shares with the $100 she reinvested. Even though Margaret now owned more shares, the value of her investment remained the same at $1,400 (107.692 shares x $13/share) because the price per share was lower. However, the $100 distribution she received increased her income tax liability for that year. Had Margaret instead waited to purchase shares until one day after the fund distributed dividends, the value of her investment would have been the same, but she would have incurred no additional current year tax liability.

Find Out When Distributions Are Scheduled

In order to delay purchasing mutual fund shares until after a distribution, you should find out when distributions are scheduled. Mutual funds must make distributions at least once per year, but may distribute gains and income monthly or quarterly. Equity mutual funds are the exception; they usually make annual year-end distributions in December. Tax planning for specific types of investments can minimize your tax liability.

Tip: The amount of tax liability you incur depends on whether your distribution is taxed as ordinary income or as long- or short-term capital gains. It also depends on your marginal tax bracket. You will receive a 1099-DIV form from the fund company reporting the amount and type of distribution (e.g., ordinary income, capital gain) in January of the following year.



This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.


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Tags: Financial Planning, Lump Sum, Pension, Retirement Planning