Transcripts

"Kevin McCormally's Tax Tips"-Mutual Fund Payout Pitfalls

SUSIE GHARIB: The calendar may say November, but we're thinking April, as in the mid-April deadline to file your Federal income taxes. Now is the time to look over your finances and find ways to keep more of your own cash and we're here to help all week with our year-end tax tips. Tonight, our tax expert, Kevin McCormally, editorial director of "Kiplinger's Personal Finance," warns don't get burned by mutual fund payouts.

KEVIN MCCORMALLY, EDITORIAL DIRECTOR, KIPLINGER'S PERSONAL FINANCE: Investors who own mutual funds in taxable accounts need to do a little investigating and some soul searching over the next couple of weeks. Go online or call your fund to get an estimate of the timing and the size of the fund's expected year-end distribution. Each year, funds must distribute to you your share of the capital gains, dividends and interest earned during the year. Before you double over laughing about the prospects of profits in this miserable year, note this little irony: even funds that have lost a bundle can make big taxable payouts. I found one Fidelity fund that is down 45 percent for the year and plans to pay out $2.85 a share. An American fund that lost 43 percent so far in 2008 will be paying out between 7 percent and 9 percent of its shrunken net asset value. How can funds that have been badly beaten up by this market have profits to pay out? Well, for one thing, as shareholders have fled, managers have been forced to sell stocks, sometimes realizing big profits to pay them off. So tens of billions of dollars in year-end distributions will show up on 1099 forms next January and will drive up tax bills by billions of dollars in April -- unless that is you do something about it now and that's where the soul searching comes in. By adding insult to injury, the prospect of a big taxable distribution adds to your incentive to bail out of a losing fund. Doing so before the distribution -- which is likely to come in December -- will let you avoid the tax bill on the payout. I'm not suggesting that you flee the market. If you like the prospects for the fund, you could reinvest in a similar fund or an ETF after it makes its distribution. I'm Kevin McCormally.