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Buy Tax-Managed Funds to Limit Your Tax Burden

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In recent days we have been writing a lot in our Mutual Fund Commentary section about retirement investment savings. While retirement investment savings are obviously crucial, the prudent investment decisions are all the more important in the wake of some Wall Street firms allegedly engaging in unfair practices when they advise retirement investors. The Wall Street firms are accused of deriving benefits via backdoor payments and hidden fees. (Read: White House Warns of Backdoor Payments for Retirement Investments).

Talking of retirement savings, it would naturally be best to get the maximum returns from the invested amount. The returns would be sweeter if an investor knows how to cut down the taxes on the capital gains. The continued Bull Run of the markets, especially in the last two years, means investors will eventually have more capital gains to pay. The new tax on net investment income along with the taxes on capital gains and others take a portion out of profit; definitely not what an investor likes for their retirement savings.

Long-term capital gains carry lower tax than short-term capital gains. Long-term capital gain tax rate stands at 15% a tax bracket of 25-39.6%. The American Taxpayer Relief Act of 2012 included qualified dividends a permanent part of the tax code. Taxes can go up to 35% in case of short-term capital gains.

The following chart depicts the tax burden a $1,000 investment and sold for $1,200 for a period more than a year would carry:

Purchase Price: $1,000  
Sale Price (Sold after 1 Yr): $1,200
Your Federal Tax Bracket: 25%
Your State Tax Rate: 15%
   
Federal Capital Gains Tax Rate: 25% 15%
Total Tax Due: $50 $60
Net Sale After Tax: $1, 150 $1, 140
Calculated Using: moneychimp.com

Thus, it is advisable to add some tax-managed or tax-exempt funds in the retirement savings portfolio. Tax-managed funds are designed to curtail the tax burden of an investor. The funds may avoid dividend-paying stocks, or may hold securities for a longer term to reduce the tax burden (as long-term capital gains carry lower tax).

Tax-managed funds may often add municipal bonds, thus enjoying interest free from federal income taxes. Moreover, tax-managed funds allow investors to decide when to realize capital gains. This makes these funds an excellent addition for retirement purposes.

It would always be great to be less worried when an investor receives the tax Form 1099. Having to pay Uncle Sam a lower tax would leave behind more cash in your pocket. Thus, adding some tax managed or tax exempted funds to your retirement savings portfolio is a prudent idea.

4 Tax-Managed Mutual Funds to Buy

Be it the IRA account or a 401(k) plan, tax benefits are a common theme.

IRAs are set up for the benefit of taxpayers or their beneficiaries, as this plan has lower long-term tax burden with the option for investors to withdraw money on reaching the retirement date. (Read: Best Funds to Buy for Your IRA).

Again, the tax-qualified, defined-contribution pension account or 401(k) plan was introduced to help taxpayers benefit from a tax break while doing their retirement savings. (Read: Mutual Funds vs. Stocks: Which Is Better for Your 401(k)?)

Here we will pick 4 mutual funds that offer tax advantages and are good choices for retirement portfolio.

The funds carry a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

Also, the funds have decent 5 and 10-year total return and carry no sales load.

These funds have high unrealized gains. These are paper gains or losses on a fund’s investments. Once sold, these gains are realized and must be distributed to shareholders.

DFA Tax Managed U.S. Equity (DTMEX - Free Report) is managed by Dimensional Fund Advisors Inc and seeks long-term capital appreciation. The fund invests its net assets in various equity securities of U.S. companies. The fund seeks to minimize the impact of federal taxes on returns by deferring the realization of net capital gains and minimizing the receipt of dividend income in order to minimize the taxable distributions to investors.

DTMEX carries a Zacks Mutual Fund Rank #2 (Buy). The fund has 5 and 10-year total return of 15.7% and 7.7%. Moreover, the 3-year annualized return is 17.7% and has returned 12.7% over the last one year. The fund’s unrealized gain is 48.2%.

DFA Tax-Managed U.S. Marketwide Value Portfolio (DTMMX - Free Report) seeks capital growth over the long term while reducing federal income taxes on returns. The fund seeks to minimize the impact of federal taxes on returns by deferring the realization of net capital gains and minimizing the receipt of dividend income in order to minimize the taxable distributions to investors.

DTMMX carries a Zacks Mutual Fund Rank #1 (Strong Buy). The fund has 5 and 10-year total return of 16.8% and 8.1%. Moreover, the 3-year annualized return is 20% and has returned 11.3% over the last one year. The fund’s unrealized gain is 44.5%.

USAA Growth and Tax Strategy (USBLX - Free Report) invests a large share of its assets in bonds and money market securities which are exempt from federal income tax. The balance of its assets is utilized to purchase blue chip stocks. The fund seeks a conservative balance between federal income tax-exempted income and capital appreciation over the long term.

USBLX carries a Zacks Mutual Fund Rank #1 (Strong Buy). The fund has 5 and 10-year total return of 10% and 6.1%. Moreover, the 3-year annualized return is 10.1% and has returned 8.9% over the last one year. The fund’s unrealized gain is 29.1%.

Goldman Sachs US Tax-Managed Equity Service (GCTSX - Free Report) aims to provide after-tax growth of capital over the long term by tax-sensitive participation in a basket of U.S. equities. The fund seeks to keep its style, capitalization, risk and industry characteristics akin to the Russell 3000 Index.

GCTSX carries a Zacks Mutual Fund Rank #1 (Strong Buy). The fund has 5 and 10-year total return of 16.3% and 7.1%. Moreover, the 3-year annualized return is 18.8% and has returned 12.4% over the last one year. The fund’s unrealized gain is 24%.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Learn more about the Zacks Mutual Fund Rank at www.zacks.com/funds/mutual-funds.


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