Managing Your Money

Timing year-end mutual fund purchases around mutual fund distributions

If you are planning on purchasing a mutual fund before the end of the year, be sure to check when the mutual fund will make its distributions. Mutual funds are required to pay out any gains and income to its shareholders at least annually. If they don’t pay those out before the end of the year, they will be subject to taxes on those gains and income.

The “record date” is the date when the mutual fund distributes it gains and income to shareholders. When a mutual fund makes a distribution the share price of the mutual fund drops by an amount equal to the amount per share that is distributed. The shareholder is required to pay taxes on the amount of the distribution that they receive.

If you purchase the fund before the record date, your purchase price includes the gain or income that is yet to be distributed. When it is distributed, the share price of the fund will drop to account for the distribution and your tax liability will increase because you have to pay taxes on the distribution received.

In other words, the fund’s gains and income are included in the price per share that you pay when you purchase the fund (if you buy if before the fund’s record date). Once the gains and income are distributed – on the record date, the fund’s share price will drop by an amount equal to the gains and income distributed. In effect, you are receiving some of your purchase price back in the form of gains and income from the mutual fund. However, the gains and income that you received are taxable. In effect, you’ve purchased a tax liability.

If, on the other hand, you purchase the fund after the record date, the effect of the distribution (i.e., the reduction in the mutual fund’s share price) will already be built into your purchase price. And, since the distribution was made before you owned the fund, you won’t have any distribution to pay taxes on.

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