Year End Tax Saving Ideas For Individuals – Mutual Fund Investments

Mutual Fund Investments

Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether a dividend will be paid early in the next year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Example: You invest $20,000 in a mutual fund at the end of 2011. You opt for automatic reinvestment of dividends. In late December of 2011, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.

Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for relief.

Tip: Wait until after the dividend to buy the shares because the share net asset value will drop after the dividend is paid. Alternatively, buy the shares in 2011, but opt to take the dividend in cash instead of having it reinvested.

In spite of these tax consequences, it may be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date.

Tip: To find out a fund’s ex-dividend date, call the fund directly.