Investing is meant to add to your wealth, with minimal costs from taxation. Knowing the way a mutual fund is taxed can help you reduce any potential taxes on your investment.
A mutual fund is an investment pool generally containing stocks or bonds. It may also contain other types of securities. Investors in a mutual fund are taxed when they realize a gain (profit) from a sale or receive income the fund generated during the year.
Unlike stocks, in which investors decide when to sell, thus determining whether they will be taxed, investors in mutual funds cannot control the sale of holdings in a fund. A mutual fund manager or team of managers decides when items in the mutual fund portfolio are sold, and thus taxed.
When the mutual fund is profitable for the year, investors receive their share of this profit in the form of a taxable distribution. This gain will be taxed at either your regular rate for income or the capital gains rate, usually 15 percent.
Buying the Distribution
If your mutual fund purchase takes place near the end of the year—meaning you haven't owned it very long—you will still owe taxes incurred from transactions that took place during that year, prior to your ownership.
Your tax bracket will determine the amount of tax you will pay for any gains realized from your mutual fund. Some mutual fund investors seek out "tax-managed funds," since these funds are managed to minimize trading activity that will increase taxation.