The dividends and interest earned by a fund on its investment
is the fund’s income. The income distribution of many equity mutual funds is quarterly.
A fund selling an investment security for a higher price than originally paid, has a gain. Selling an investment security
for a lower price than originally paid, has a loss. If the investment security is held by the mutual fund for more than
one year, the gain or loss will be a "long-term" capital gain or loss. If the investment security is held for less than
one year, the gain or loss will be a "short-term" capital gain or loss. Mutual funds gains and losses are netted together
and when the fund has a net gain, that gain is usually distributed to the shareholder once a year.
Some investment advisors recommend avoiding mutual funds
that give dividends/capital gains. The reason? Tax consequence incurred when the distribution is made.
However; there is another position to consider and that is when planning for investment growth in an Individual Retirement
Account (IRA).
IRA investors reinvest the distribution and acquire additional shares
in the mutual fund account. This type of investment is very beneficial because:
- investor's shares are increased
- dollar-cost-averaging is achieved
- taxes are deferred until the shares are
redeemed
- investment objective growth is obtained.
Retirement planning is not maximizing rate of return but
maintaining a comfortable lifestyle in all market conditions.
The current 15%
tax rate on capital gains and dividends that Congress approved will expire after 2011. At that time, dividends will
be taxed at ordinary income tax rates and capital gains at 20%. However; legislation is being considered to extend these
contribution limits. Another bill in legislation is targeted to encourage personal savings in mutual funds by deferring taxation
on automatically reinvested capital gains until the shares are sold. Currently capital gains are taxed each year even
if they were reinvested. An excellent source of additonal information can be found at www.FundingYourFuture.org.
