Vanguard Target Retirement Funds Huge Capital Gains Distribution

Finance
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22

Or just sell before the distribution happened ideally. In this case it would have been roughly a wash to sell the same year but afterwards

https://investor.vanguard.com/mutual-funds/profile/distributions/vforx

But that depends on the tax character of the distribution. If you’re getting mostly dividends or short term capital gains in the distribution, if you sell after the ex date and get a capital loss, that won’t necessarily be a good tax outcome compared to nothing at all (ie definitely taxable income vs possibly limited capital loss deductions if you don’t have lots of gains aside from this).

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If you sell all your shares that year, then [for the most part] it doesnt matter if it’s before or after the distribution. Besides potential market fluctuation, of course. But there really isnt anything “smart” about doing so.

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No, that very much depends on what the tax treatment of the distribution is. Best case it’s a wash if you sell after, worst case is you pay full ordinary taxes on it and get an equal long term capital loss you can only use up $3k/year. Front loading your tax bill a lot…

If you don’t have big embedded gains from lots of appreciation, it’s usually right to sell before the payment and then rebuy as appropriate if you want after.

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25

I did say “for the most part”. :slight_smile:

In general, a $4 distribution will only mean your total gain/loss on the sale will be $4 lower. As noted earlier, the distribution could be short term while your sale gain is long term, but the reverse could be true as well - in which case the distribution converts “ordinary” short term gain into a long term gain with better tax rates.

The long term capital loss that is limited to $3k/year (it really isnt a $3k limit per year, the large loss will offset all current-year gains plus an additional $3k) is only relevant when selling in a subsequent tax year. This question and reply was specifically about selling in the same year.

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26

Capital gains distributions can/do happen with any mutual fund right? Some mutual funds are toing to be more susceptable to larger distributions.

This situation with Vanguard retirement funds seems like an anomoly mroe than not, but the situation has existed kinda forever.

I guess the only real solution is to keep your funds in tax protected retirement accounts ? I think thats what they’re designed for to begin with.

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27

So what do you keep in your taxable accounts? I thought I’d be safe since this fund holds mostly VTSAX but as I learned, that was a wrong assumption to make as I would have been fine if I had invested directly in VTSAX instead of a fun that invested in the fund.

Now I need to re-think all my accounts. Do I change and remove bonds from all tax exempt accounts and only put bonds in taxable accounts? I already have REIT’s and such in tax-free accounts but never thought the Target Date funds would hose me this bad. I’m going to have to really think about this and do some research and reading.

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Just a tip from an old timer who once had mega amounts of money in (real) bonds of all sorts. And forgive me please if, when you wrote “bonds” you actually meant bonds, and not bond funds.

But if (and only if) you did mean bond funds:

Stay away from them. They are poison.

Actual, individual, bonds on the other hand are fine.

They helped me to retire permanently at age 40. :grinning:

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29

I think the lesson here is individual stocks or ETFs. For the lazy, you could use Wealthfront for automatic tax loss harvesting. Or DIY. They basically trade equivalent ETFs back and forth to “bank” losses.

IMO tax-efficient investments should not be made in tax-advantaged accounts. However, not all bonds are the same: government bonds are more tax-efficient than corporate bonds, for example, since govt (federal, state, muni) bond interest is exempt from some taxes.

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What’s the difference? Don’t bond funds just invest in the actual individual bonds?

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I just knew somebody would ask about that. And, darn it, it’s been literally decades since the people who taught me about this inculcated their lessons and reasons. The most I’m able to remember now is this:

Bond funds never mature. Individual bonds do.

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32

What’s the practical difference between me owning bonds directly or me owning a fund that owns bonds directly? The bonds will mature and pay out either way – one way into my account, another way into the fund that’s in my account.

33

Because bond funds do not hold bonds that all mature on a given date. Where holding an individual bond locks in a return until maturity no matter how much it may fluctuate until then, a bond fund has perpetual interest rate risk.

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34

As does an individual account that holds many bonds with different maturities, no?

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Sure. But you can stop buying new bonds. Once you own a bond fund, there will never be a defined end date, on which to project an expected return. They keep buying bonds under any market condition - unless the fund itself is terminated, at which point you’re at the mercy of market conditions when it’s liquidated. There is no yield-to-maturity baseline expectation with a bond fund.

I dont know that I agree with the extreme objections to bond funds, but bond funds are an entirely different investment than picking an individual bond with a good yield then holding it to maturity.

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36

Here are several bad cases to watch out for

  1. You have long term gains in the fund. They are distributing lots of short term gains, which will be taxed at a higher rate. Depending on the size of distribution vs your gains, selling before the distribution could get you a better tax rate.

  2. You have no appreciable gains in the fund, and they’re doing a large distribution. If you sell beforehand, there’s no problems. If you sell afterward, now you have a large unrealized capital loss and taxable income from the distribution. Future capital losses can only be used against other gains or in a limited fashion against other income. Ie.

30% distribution of short term gains
33% tax rate
$100k invested
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You get a tax bill for $30k of ordinary income
You pay $10k in extra tax right now
You have a future $30k capital loss, which can’t offset that income even if you sell the same year. It could take 10 years to fully recapture that tax loss.

If it’s a long term gain distribution instead of short term, you can come out even by selling the same calendar year. If it’s across years, ie you forgot to sell until the next year, you can have the same issue of front loaded taxes and a large carry forward loss that may be difficult to use up.

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37

That’s predicated on you intending to sell anyways. If you intend to hold the fund indefinitely, any attempt to sell/repurchase to avoid the annual distribution is going to be mostly counterproductive.

And maybe I’m wrong and the info is available somewhere, but do you even know what a fund is distributing until after it’s been distributed? I dont know how you can ‘watch out for’ such bad circumstances so that they can be avoided?

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All mutual fund companies put out tax estimates for end of year distributions in advance. You just have to look for them. I’ll post the vanguard one when I can find the link.

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I think it was put out around Dec 10-15 and only if you knew to go look for it. The capital gains was on 12/29.

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40

This link was available with preliminary EOY distributions for Vanguard at least as early as Nov 28th when I saw it. They have the various deadline dates and estimated a 15% distribution for the 2040 TR fund. The last day to sell to avoid this was Dec 17th, so you had 3 weeks or so to notice.

https://advisors.vanguard.com//iwe/pdf/taxcenter/FAPYEEST.pdf

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41

Being America, where you can sue for anything, Vanguard is getting sued to their management that allowed this bad tax outcome to happen to people like OP. Below from Matt Levine’s column

https://www.bloomberg.com/opinion/articles/2022-03-21/everyone-wants-to-do-esg-now

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Generally speaking [mutual fund capital gain distributions] is a small constant drag: You invest in a mutual fund with lots of other people, and every year some of them withdraw their money (to pay for retirement or to buy different mutual funds or whatever), and you have to pay some taxes on some of your gains. But if you invest in a mutual fund with 1,000 other people, and they all decide to withdraw from the mutual fund at the same time, then the mutual fund will have to sell almost all of its stocks, which means that you will have to pay taxes on almost all of your unrealized gains in the fund all at once, and you will be annoyed.

Here’s a weird lawsuit against the Vanguard Group:

Vanguard offers “set-it-and-forget-it” target date retirement funds. These funds are organized as a trust and managed by the same trustees. The investment strategy is based on a target retirement year, such as 2030 or 2050. Vanguard offers two tiers of target date funds: (1) funds for individuals and retirement plans with less than $100M (the “Retail Funds”); and (2) funds for retirement plans with over $100M (the “Institutional Funds”). The strategy and investments are the same, but the Institutional Funds charge lower management fees. ….

Normally, target date funds don’t sell many assets, so capital gains distributions are minimal. But beginning in December of 2020, Vanguard itself caused an “elephant stampede” sell off from its Retail Funds. Vanguard chose to open its Institutional Funds (which hold the same assets as the Retail Funds) to all retirement plans with at least $5M, so that retirement plans invested in the Retail Funds could sell their shares and move over to cheaper, but otherwise identical, Institutional Funds. And this is what happened.

To raise cash to redeem so many shares, the Retail Funds were forced to sell off as much as 15% of their assets (or even more). When these assets were sold, the Retail Funds recognized capital gains on the assets. The resulting capital gains distributions to investors were unprecedented (40 times previous levels). While this didn’t hurt retirement plans, it left taxable investors holding the tax bag.

Vanguard had other, readily-available ways to lower costs for retirement plans without hurting its taxable investors. But it either did not even consider these options, or did not care about hurting its smaller, taxable investors. This was a gross violation of Vanguard’s fiduciary duties (among other legal duties).

Much of the money in this fund was in corporate 401(k)s, which don’t care about incurring taxes. Some of it was in individual taxable accounts, which do care, and which did incur taxes when the corporate 401(k)s sold. Is that a reason to sue Vanguard? I don’t know.

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