Mutual Fund Education
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These distributions can either be reinvested back into the fund or paid out, but the choice does not affect the taxable status of the distribution. Distributions made by mutual funds held within a tax-advantaged account such as an IRA or 401(k) are not taxable.
For more information on the taxation of mutual funds, take a look at our article on How Mutual Funds Are Taxed.
There are four primary types of mutual fund distributions:
Besides mutual funds, exchange traded funds (ETFs) also provide distributions.
Distributions are split into short-term and long-term gains. Short-term gains are those that are generated from securities held for less than one year, while long-term gains come from securities held longer than one year. Long-term capital gains are taxed at the long-term capital gains rate, which can range from 0% to 20% depending on the shareholder’s tax bracket. Short-term capital gains are taxable at the shareholder’s ordinary income tax rate, which can range from 10% to 39.6%.
In this regard, check out the Fidelity Contrafund (FCNTX) that often makes capital gains distributions.
For more information, check out our article on ETF Distributions and Capital Gains.
The T. Rowe Price Equity Income Fund (PRFDX) is a fund that pays a quarterly dividend.
Find out how much you can make investing in dividend paying stocks with Dividend.com’s Dividend Reinvestment Calculator.
From the mutual fund’s standpoint, dividends and interest are essentially treated the same. When a mutual fund makes a dividend distribution, it’s the income accrued from the combination of equity dividends and bond interest.
The Vanguard Total Bond Market Index Fund (VBMFX) is a fund that pays the interest accrued from its fixed income investments every month.
Return of capital distributions occur most frequently with real estate investment trusts (REITs) and master limited partnerships (MLPs). These investments will occasionally return capital to shareholders when the fund is unable to generate enough income from its investments to make expected payments and needs to use original investor capital to make up the difference.
The Vanguard REIT Index Fund (VGSIX) is an example of a fund that has made return of capital distributions in the past.
To learn more about taxation of mutual fund distributions, check out the Taxation section on our website.
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Mutual Fund Education