I’ve been using a CPA to do taxes for several years since my wife started a side business because it’s easier and worth the $400 to have it done right. Anyway, I get my returns today and I thought there must be some typo as it says I owe an additional $75+k. I’m furiously going through the return to find the typo and finally see that the Vanguard 1099 is showing a $220k capital gain from my Target Retirement 2040 account (VFORX). The previous year it was $4k.
Long story short, Vanguard lowered the institutional version of the fund so you only needed $5M instead of $100M so it looks like several small business moved over to the institutional (about $10B move). Vanguard sold assets which triggered huge capital gains.
I’m on the hook for almost $50k extra in federal and state taxes for this. I can’t believe Vanguard is this stupid. The short of it is does anyone know a lawyer that would look at doing a class action lawsuit for this? There are others that are paying 6 figure extra in taxes this year due to Vanguard’s actions.
I’m so disgusted with Vanguard right now that I’m not even sure what to do, other than pay my taxes so I’m not a deadbeat
You could appreciate the fact that your investment increased is value so much? Your situation sucks, but, I mean, there really isnt much Vanguard could’ve done beside not investing so successfully in the first place. If you dont want to pay the tax on the gain, I’m sure they would be willing to give the gain to someone else instead (or give me the $220k, and I’ll pay the tax for you).
If you want to control your tax bill, you need to make the individual investments yourself so you control when the gains are realized.
The modest silver lining is that this also adjusted your cost basis it’ll cost you less in future withdrawals. Not much of a reprieve when you have to pay the much higher tax bill now… I know.
How true is that though? What if he put all his money into VFORX on December 1st? Does the fund care that he wasn’t in it while it appreciated and just hit him with his share at the time of distribution a month later?
Yes, I was going to qualify that with not knowing the timeframe involved. But given the approz $1.5-million investment necessary to generate that $220k capital gains distribution, I though it was rather reasonable assumption that he didnt just buy in the end of the year.
The curious thing here is that without his $400 CPA he had no clue there’d be tax due on a 15% cap gains distribution that posted to his account nearly 3 months ago. And that over $25k of the tax owed is apparently from something else.
Many many mutual fund investors were in this situation last year. Nearly 1,000 had 10% or higher gain distributions, so you had a lot of company. Vanguard mid cap growth paid out over 1/4 of its NAV last year, not just 15% like your TR2040 fund. I think this broadly was a combination of panic redemptions around the covid crash followed by huge gains since then in stocks that lead to high turnover in both many funds’ holdings and in their investor base.
You think that was bad, look at Pimco’s PTSOX - for those investors it was over 50%! You would have owed $200k more in taxes for that one, even if you’d only bought it last fall and didn’t have any gains.
Nope. Worse, if you weren’t paying attention such as your situation, you wouldn’t have sold last year and been stuck with hundreds of thousands in unrealized losses which are small and much less valuable compensation for paying a huge front-loaded tax bill. With other funds it could have been a million in unreleased losses for an investment made 4 months ago and which is probably down to boot!
Probably the best thing to avoid this is to use ETFs rather than mutual funds - their tax breaks are much better and avoid most of these issues.
Not really. They have to sell when their investors redeem, and what they sell for a retirement fund is a simple mix of whatever they hold. If those are appreciated holdings, they must distribute the realized capital gains at EOY to whoever’s still holding the fund.
The above article describes this process and how it’s not exactly “fair”.
Imagine if you had bought TR 2040 in your taxable account in November 2021. You didn’t really have much of a return that year, but you still got walloped with the same 18% LTCG distribution. This is the case with many mutual funds. When you buy into a mutual fund, it often already has some embedded capital gains. If a large investor leaves the fund and forces the fund to sell shares of those low-basis securities, you’ll be left holding the LTCG bag.
So if you sold the shares just before the distribution, you would owe less taxes than if you sold them right after the distribution? Seems to violate the very definition of capital gain. Buying an “embedded capital gain” is not a capital gain to the buyer, it’s part of the buyer’s cost basis… Why couldn’t part of that LTCG distribution be reclassified as return of capital? Because that’s really what it is.
It sounds so terribly wrong and probably affected so many wealthy people there should be an effort to change the laws to fix it retroactively.
That’s correct. If you had inadvertently bought it recently, you’d have no real gain and could get stuck with taxable income (STCGs are ordinary dividends when paid from RICs like mutual funds, not capital gains) to the tune of 10-60% of your principle last year. Don’t do this!
as for why it’s this way, it’s just the greedy feds hating the idea that people could get tax deferred investment growth while actively changing their holdings (which is what one would naively propose to avoid this), so they make the fund vehicle keep track of its internal gains and pass them out annually to the shareholders. But of course those shareholders might not exactly be the same ones who made the money due to the accounting, but who cares about them as long as the IRS gets the money it’s entitled to, or more?
No, all other things being equal, because the share price is adjusted for the distribution. You sell before the distribution at $50/sh, or you sell after the distribution for $46/sh plus the $4/sh cap gains distribution. Any variance from that is a function of the market changing while holding it those additional days, not a function of the distribution. The main difference is timing - with the distribution you’d pay tax on the $4 today and the $46 tomorrow, while without the distribution you pay tax on the full $50 tomorrow.
It would be possible for your tax to be less by selling after the distribution - if you purchased the fund less than a year ago, making the $46 a short term gain, while the $4 might be long term gain. Sell before the distribution, and it’s all short term gain. And, of course, the opposite could happen too, if the fund distributes some short term gains while your holding is all long term. (Obviously, I hope, there’s a cost basis deducted from the share price to determine gain, but that’s not relevant to the point being made.)
Where it sucks is when you pay tax on a $100k cap gains distribution today, only to realize a $100k capital loss when selling the fund tomorrow. The $100k gain usually hurts more today, than the $100k loss helps tomorrow.
Here is the main issue: VFORX is a fund of funds which means it simply has Total Stock Market Index Fund, Bond Fund, etc. If I would have put the same exact money in those funds, I would have had about $5k in capital gains instead of $220k. The issue is with a conscience decision that Vanguard made where they made it easier for small business to switch from the VFORX to the Institutional version of the same fund. It appears that about $10 billion was sold in VFORX and moved to the Institutional fund when Vanguard lowered the minimum threshold from $100 million to $5 million. This was a decision that Vanguard made and they either did not think of the repercussion or did not care.
Because this $10 billion moved out of the fund, they had to sell assets which caused the huge gain. For reference, the capital gains per share distribution was $0.13 in 2020 but $7.55 in 2021 even though the market gains in 2020 were similar to 2021. Vanguard made the decision to lower the threshold in the Institutional fund by 95%. They chose to screw their individual investors for the sake of their institutional investors. Again, this was either a deliberate decision or a colossal mistake on their part.
For reference, the capital gains distribution for the VFORX was 15.55% of NAV while the same fund for Institutional investors was 0.39% of NAV. So obviously the charges were not from the index, but from the fact that there was a large movement of funds from the VFORX to the Institutional fund that required them to sell assets thereby causing the large capital gain.
I can remember this problem, speaking generically, being discussed back in the 1980s. I do NOT recall any examples as egregious as that illuminated by the OP here. But the principle has always been the same, that of an uncontrollable tax vulnerability to which mutual fund owners are inherently exposed. Mutual funds offer certain investment advantages. This sort of surprise is not among them.
Laziness. I didn’t think there would be a real difference with just using the Target account instead of buying the individual stock/bond accounts. That was a costly mistake.
So for any recent investor in the fund that didn’t actually have all that much in gains, the smart thing to do would have been to sell all their shares in the same year as that distribution was made, right?
