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DON'T BUY SOMEONE ELSE'S TAX BILL

December 15, 2007

It's not a good idea to spend your hard-earned money for the privilege of paying taxes on someone else's earnings. That means you should be careful if you buy mutual funds in December.

The tax law requires mutual funds to distribute capital gains on their stock sales annually, and most distribute the whole amount in December. If you buy into a mutual fund the day before the distribution, you buy a share of the whole year's liability.

Many funds put the amounts and dates of expected capital gain distributions on their web site. It's worth a few minutes on the web to avoid buying a year's worth of mutual fund tax liability.

There is another handy way to avoid capital gain distributions: stick with index funds. These funds only trade to track changes in the components of their indexes, so they have very small capital gain distributions. If you visit the Vanguard Funds 2007 capital gain distribution list, you will find only one index fund with a capital gain distribtion - and only for a penny per share. Contrast that with the actively-traded funds, with taxable distributions as high as $8.37 per share.

For more on fund distributions, here is a good Kiplinger article. For more on index fund investing in general, go here or here.

This is another installment of our series of 2007 year-end planning ideas. Don't miss a one!

Tags: year-end tax planning.

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