In the decade after the dot-comboom ended, investors were in for a surprise. Even though many of their mutual lost value in the first few years of that decade, they still owed .
Well, capital on those trades, so must you.do their own buying and selling, and even in a year when the lost value, the managers may have still sold their positions in winning . And because the must reflect
A Solution Other Than Mutual Funds
Fast forward to 2013, and many investors have ditched their mutual ETFs). Whereas most mutual funds charge annual fees approaching 2% or even 3%, ETFs typically charge less than 1% annually. In some instances, such as the Vanguard S&P 500 (NYSE: VOO), the expense can be an absurdly low 0.05%. Add it up over the years, and these small differences in annual expenses can big savings for your portfolio., shifting their to lower-cost exchange-traded (
But as is the case with mutual funds, ETFs have tricky tax codes that can trip up unwitting investors. And in a moment, I'll explain how you can side-step the whole mess.
Many ETFs, even if they didn't rise in value in the past year, can trigger capital futures contracts or currencies, the you'll owe vary.. And depending on what investors own, the can become burdensome. , for reasons that are not fully clear to most of us, applies different rates to different types of assets. Whether these ETFs own , commodities,
But there's a solution.
First, here's a closer look at the tax laws.
The majority of ETFs own stocks, and since they tend to simply those , they don't generate an especially large amount of capital during years when they lose value (unlike mutual funds, which have a high degree of turnover and therefore might trigger capital in good years and bad).
As is the case with stocks, your income tax bracket, or 15% capital tax rate if your income tax bracket is higher. Yet, if you hold that for less than a year, then the taxes you owe are the same as your income .matters. If you own a stock-focused for more than one year, then you'll be taxed at the long-term capital rate, which currently stands at 0% if you are in a 10% of 15%
ETF Tax Implications
But if you own anthat focuses on other assets, then the tax implications can become tricky. Here's a short explanation of the distinctions:
- Currency-focused ETFs, such as the PowerShares DB US Dollar ordinary income. (NYSE: UUP), are set up under special financial arrangements known as ' trusts.' These trusts simply pass on and losses to investors, without any special capital treatments. An exception is made for ETFs that solely own foreign currencies, which are taxed as
- Futures-focused ETFs, such as the PowerShares DB Tracking (NYSE: DBC), are treated as if they generate 60% long-term capital and 40% short-term capital . If you are looking to buy these ETFs, the sponsor and talk to a service representative about the real-world tax implications of such funds.
- Precious metals-focused ETFs that own items such as gold bullion or physically hold other precious metals, such as the Gold (NYSE: GLD), are treated as if they are collectible items. The taxes on these assets are treated as ordinary income if you hold them for less than a year, but are taxed at a rate of 28% if they are held for a longer timeframe. Here again, a to the sponsor's hotline is advisable to understand the tax ramifications.
One Easy Trick
But I've found a way to skirt around the tax burden of ETFs. Here it is...
Thanks to the unnecessary complexity of all of these tax rules, it may be wisest to avoid the problem altogether. You can do that by keeping all of yourin retirement accounts such as 401(k)s and IRAs. Instead of figuring out your tax bite year after year, you'll simply owe taxes on profits accrued for the lifetime of that retirement account, once you start to withdraw after age 59 1/2.
For that matter, you should assess almost of all of your eventually be taxed when you start to make withdrawals, you are likely to be in a lower tax bracket -- if you have stopped working.choices in the context of your taxable vs. non-taxable portfolios. In most instances, the non-taxable portfolios such as IRAs or 401(k)s should be the primary recipient of your dollars. Although these
The Answer: There are many good reasons to invest in ETFs, including portfolio and the simplicity of . And although they have fewer tax implications than mutual funds, they still can trigger an unexpected tax bite. The major sponsors of ETFs such as Barclays, Wisdom Tree, Vanguard and others can furnish you with brochures that spell out the tax implications for each of the you may be considering. These tax complexities may seem daunting initially, but once you have a grasp on the , you'll be ready to on this important emerging form of .