A bill recently introduced in Congress would revolutionize the way mutual-fund gains are taxed, but it was virtually ignored by the media...
A bill recently introduced in Congress would revolutionize the way mutual-fund gains are taxed, but it was virtually ignored by the media and remains almost entirely unknown by the public.
That’s because no one thinks the legislation will pass, at least not during this Congress. But the Generating Retirement Ownership Through Long-Term Holdings Act, also known as the GROWTH Act, provides fund shareholders with a glimpse into what the future could be, and it’s a view that should get fund investors excited. The bill would allow fund investors to defer capital-gains taxes on reinvested distributions until funds were sold, a change that would make funds more attractive, simplify personal accounting and show an alarming amount of common sense.
By law, funds must pass virtually all capital gains — profits from trading in investments — to shareholders each year. Unless the fund is held in a tax-advantaged account, those distributed gains are taxable at capital-gains rates, even if the investor never sells the fund nor touches the money.
Since the bull market ended, investors have learned all too frequently that a fund can lose money but still have gains to distribute, creating a tax bill but no annual profit.
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(Investors who do not adjust their cost basis to account for those annual taxes may also overpay Uncle Sam when they eventually sell the fund. Deferring taxes on the gains would end that problem.)
In 2000, funds made $326 billion in capital-gains distributions, according to the Investment Company Institute (ICI), with $114 billion of that paid to taxable accounts.
Last year, according to the ICI, funds paid out $55 billion in distributions, and 40 percent of that money went to taxable accounts. That was the biggest gains payout since 2001.
The GROWTH Act was introduced by Rep. Paul Ryan, R-Wis., and Rep. William Jefferson, D-La. It would cover long-term capital gains only. Interest income, dividends and short-term-trading profits, which a fund must also pass to shareholders, would not be affected. Those distributions are taxed at an investor’s ordinary income-tax rate.
By comparison, investors in individual stocks pay capital-gains taxes only after unloading the stocks at a profit. That lets stock investors decide when to pay gains on their securities, while fund investors pay whenever a fund makes a distribution.
By allowing an investor to save in a fund without paying taxes on distributions, for life, the bill effectively would create the “lifetime savings account” that President Bush has suggested, without giving it the formal name.
A so-called taxable fund account effectively would become like a traditional individual retirement account, without the contribution limits.
But the bill has no hope of getting out of Congress until Social Security gets resolved.
But in many ways, the government is looking for ways to reward accumulation and long payout structures, so that people don’t take their money too quickly and use it up.
Clearly, the GROWTH Act falls along those lines. If mutual-fund tax change is ever going to make sense, this is how it will look. The question is whether it will ever get done.
Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at email@example.com or Box 70, Cohasset, MA 02025-0070.