Year-End Capital Gains Season: Why Mutual Fund Distributions Can Surprise You (and 5 Tax-Planning Reminders)
Mutual funds can force capital gains into your taxable account, and it may make sense to focus on structures and year-end tactics that put you back in control.
The mutual fund structure has existed for about eight decades, and it offers plenty of potential benefits. Diversification, professional management, low minimums, and liquidity are just a few. Mutual funds may be appropriate in many situations, but they can cause tax complications for investors who own fund shares in taxable accounts, especially actively managed mutual funds.
Mutual funds are required to distribute income and realized gains to shareholders each year. It is common for these distributions to occur in November and December.
The potential problem: investors in these funds can owe income tax on distributions even if they did not sell their shares. Making matters potentially worse – it doesn’t matter how long the shareholder has held their shares. The tax treatment of the distribution – ordinary income, qualified dividend, or capital gain) depends on the investment owned by the fund, as well as its holding period. Other structures like exchange-traded funds (ETFs) often reduce these capital gain distributions.
Many fund companies will publish year-end capital gain estimates in September or October. Before making year-end mutual fund purchases in taxable accounts, it would be wise to review these estimates to avoid receiving unexpected – and unwanted – income.
To read more about these mutual fund distributions and potential alternatives, click on the following link: Why I Had a Tax Surprise, and How I Hope to Avoid it in the Future.
5 Year-End Tax Planning Reminders
Get the most out of 401(k)s and other retirement plans
For many high earning W-2 employees, one of the best ways to reduce taxable income is to contribute to a pre-tax 401(k) or other retirement plan. Review your account to see if you’re reaching your contribution goal. What if contributing the maximum isn’t an option? Consider contributing enough to receive the full company match. Aiming to contribute at least this much to the company retirement plan can make a big impact over time.
Review annual gifting for potential tax savings
Want to give to family or others? The annual gift limit for 2025 is $19,000 per recipient. Gifts under the annual exclusion limit generally do not require a gift tax return and do not create taxable income for the recipient.
Charitable families may want to review giving as well. Charitable contributions may be deductible if the filer itemizes deductions. The standard deduction has grown in recent years, which can make it difficult to receive the tax benefits from giving. These families may want to consider lumping multiple years’ worth of giving via a donor advised fund (DAF). Distributions from the DAF can be used support their preferred organizations, and the larger contribution to the DAF may qualify the donor for the tax deduction.
IRA owners aged 70½ or older can make Qualified Charitable Distributions (QCDs) directly from their IRA to eligible charities. These QCDs satisfy required distributions and, when handled properly, are not considered income to the IRA owner.
Finally, consider giving assets other than cash. Gifting appreciated securities can be a good option if the recipient is able to accept these contributions. Keep in mind, the recipient usually inherits the donor’s original cost basis and holding period. The donor can also repurchase the same security and establish a new (and hopefully much higher) cost basis.
Review gains and losses, harvesting where it makes sense
2025 has generally been a good year for investors and markets have risen significantly from their March/April lows. Losses may be hard to find. Still, it may be worthwhile to review taxable accounts for opportunities to realize losses that can offset other gains, and be mindful of wash sale rules.
It could make sense to realize gains as well. Prime gain-harvesting candidates would be families whose income is below the 15% capital gain threshold, allowing them to realize gains and pay 0% federal income tax. Child accounts like Uniform Gifts to Minors Act or Uniform Transfers to Minors Act accounts (UGMAs/UTMAs) can also be good candidates but understanding the potential impact of kiddie tax rules first is a must. State taxes may still apply.
Consider adding to the “tax-free” bucket
Qualified distributions from Roth accounts may be tax-free. But many high income families are phased out of making Roth IRA contributions. Roth conversions might be worth considering by:
Targeting low-income years,
Pairing with contributions to DAFs to help offset the additional income, or
Using backdoor Roth strategies but first make sure you understand the pro rata rules and tax implications!
Converted assets will typically increase income. Retirees sensitive to changes in Medicare premiums should consider IRMAA brackets carefully before completing these conversions.
Some workplace retirement plans allow for after-tax contributions and in-plan Roth conversions. The “mega” backdoor Roth strategy can be another way to build Roth assets, quickly. Click here to read more about the "mega" backdoor Roth.
Review individual investment accounts for potential tax leaks
Asset allocation – the mix between stocks, bonds, and other assets – can have a large influence on a portfolio’s risk and return. Asset location – the strategic placement of certain investments in certain account types – can have a significant impact on the after-tax returns earned by investors. Are your investment’s returns primarily ordinary income, tax-free income, dividends, capital gains, or a mix of each? How and where investments are owned may matter more than you realize. Read more about the potential benefits of asset location here.
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