How to Avoid Big Taxes on Capital Gains From Mutual Funds

Many people who own mutual funds know they are typically a good way to save on taxes because capital gains are taxed at about half the rate of regular income. It’s one of the most common ways that the super rich make so much money and still pay a lot less in taxes. However, for those who have owned certain mutual funds for a long period of time, the taxman is going to come knocking this year.

Selloffs Means Realized Gains

That’s because financial experts expect several mutual funds to give out large capital gains to those who own shares. That means those shareholders can expect to pay taxes on them. That includes stock mutual funds that recently sold after bringing large gains with them from 2013. So why is this happening? Because mutual funds have to distribute actual gains every year to their shareholders. Why is 2014 different? This year, because there have been many big stock selloffs, those who manage both stock funds and bonds might have to finally realize their gains.

Time to Pay Finally Up

In the past, many investors have been using those taxable gains to help offset their losses from 2008 and 2009 when the stock market was hit extremely hard. They have been carrying those losses since then, but for many, those losses are now all used up. That means they have to take the full brunt of this year’s gains. If those gains are considered long-term, then the tax rate is usually 15 percent. However, anyone in the top tax bracket can expect a capital gains tax rate of 20 percent.

Stock Funds Could Be Hit Harder

Meanwhile, for those who invest in stock funds, the news could be even tougher to swallow. According to one financial analyst, the U.S. domestic stock funds gains might reach as high as 20 percent, which means those investors could pay as much as much as 16-17 percent of their value as gains to those who hold shares. One important fact to keep in mind, however, is that investors who carry mutual funds in retirement accounts do not have to pay taxes on fund earnings every year.

Savings Strategies

For those who don’t fall into this category, there is little they can do to offset this issue. However, there are some strategies that could lessen the blow. Let’s take a look at a few of them.

  • If you happened to have recently purchased these mutual funds then you might want to sell them promptly. If you get out before the gains are distributed you could avoid the tax.
  • Don’t buy any mutual funds for the rest of this year until you know when the company is distributing its gains. Buying before the distribution could mean you miss out on the actual gains but you would still be liable for the tax.
  • If you have lost any money from other funds or stocks then now might be the time to sell those shares and take the loss. That could help offset your gains from strong performing mutual funds.
  • Just take your pill and swallow it, so to speak. Even if you do have to pay a tax on your capital gains, remember that 15-20 percent is still lower than rate for regular income.