2023 Year End Action Items

Hello and thank you for joining us for our 2023 Year End Action Items webinar.

It's hard to believe, but the end of the year is upon us, which means it’s time to review your investment accounts and financial plan to ensure you’re closing out the year on firm footing.

I'm Lindsay Theodore, a certified financial planner professional and Thought Leadership Senior Manager here at T. Rowe Price. Today we'll be exploring several actions you may want to take to get your financial house in order as 2023 comes to a close. We’ll discuss items that may impact your taxable income and how you might manage these liabilities, as well as cover some tax-savvy ways to allocate assets to the people and the causes you care about.

We'll discuss capital gains and required minimum distributions, both of which may increase your taxable income. We'll also explore charitable giving as well as 529 college savings plan contributions and IRA contributions, all of which may decrease your taxable income. And lastly, we’ll cover a few housekeeping items that are valuable to review at the end of the year such as making sure your beneficiaries, account services, and registrations are set up in line with your intent.

Joining me to talk about an item that may increase your taxable income is Roger Young, a certified financial planner professional and thought leadership director here at T. Rowe Price. Thank you for joining me, Roger.

Roger: Thanks, Lindsay. I'm happy to be here.

Lindsay: Let’s start by reviewing an item that may increase a client’s taxable income. Can you please define year-end mutual fund capital gain distributions and how they work?

Roger: Sure. So, over the course of a year mutual funds buy and sell securities to meet their investment objectives, seek investment opportunities, and manage the cash flow in and out of a mutual fund. These actions result in capital gains and losses in the individual securities the fund holds. The realized gains, to the extent they exceed realized losses, are then paid out of the fund. That’s known as a capital gain distribution. The IRS generally requires mutual funds to distribute all income resulting from net capital gains to their shareholders each year. This results in a taxable event for investors in taxable accounts, whether they receive those payouts in cash or reinvest them in additional fund shares.

Now, this is treated differently if the mutual fund is held in a tax-advantaged account like an IRA. Money isn't taxed while in the IRA, but may be considered taxable income once you start pulling the money out.

Lindsay: So, when a portfolio manager sells for a gain within a fund they trigger a taxable event for the fund. Since the fund is owned by shareholders, that capital gain is then passed onto the individuals owning the fund. Keep in mind when a mutual fund sells a position it may result in a gain or loss. The IRS allows mutual funds to offset gains with the losses to reduce the tax liability. And, the IRS allows mutual fund managers to carry these losses forward to future years. The portfolio manager may be able to offset gains over multiple years. But if these carryover losses have already been used, it may result in sizable capital gain distributions for mutual fund shareholders. Since the individual investor isn't the one who triggers the capital gain, what are some actions investors can take to prepare for the year-end payouts?

Roger: Since each investor's circumstance is unique, working with a tax professional to determine the most appropriate action is always recommended. But it's important for investors to know that when capital gains are distributed, those amounts are not taxed again. If you reinvest, your cost basis is adjusted. and increases every time there is a capital gains distribution and reinvestment in that holding. You are only ultimately taxed on the profits you receive. Now, investors might be tempted to proactively sell the mutual fund prior to the record date which is the date the eligible ownership is determined. But there are a couple of considerations.

This action may still result in a taxable event if you personally have an embedded gain. You also want to consider short-term versus long-term gains when assessing the tax impact of the distribution. Long-term capital gain tax rates are more favorable than short-term capital gain tax rates.

Lindsay: Great points, Roger. And, just as fund managers can harvest investment losses throughout the year, individuals have that option as well. Especially in a year when the markets have declined, there may be opportunities to harvest losses to offset realized gains, or carry forward for use against capital gains in future years. Of course, you would want to ensure that any changes you make are appropriate given your risk tolerance, time horizon, and asset allocation target. You may also want to consult a tax professional to ensure that you don’t violate the wash sale rule, which would reduce or eliminate the benefit of tax loss harvesting. And what if investors are considering purchasing a mutual fund close to the record date?

Roger: If the capital gain will be distributed soon, you may want to consider waiting until after the distribution to make that purchase. This way you avoid a taxable event when you haven't even been able to benefit from any growth over time. Remember, this is only a potential issue for taxable accounts. This does not affect IRAs, for example.

If you find yourself uncomfortable with these types of payouts and are more concerned with minimizing a tax liability, you could consider other types of mutual funds that attempt to limit these distributions, such as tax-efficient funds. As always, make sure any fund is aligned to your investment objective. It's also important that shareholders understand the share price of the mutual fund will go down on the day of the capital gain distribution. Essentially the value to the shareholder is the same. The capital gain amount is offset by a reduced share price.

This date is called the ex dividend reinvestment date. On this date distribution amounts are reinvested or paid in cash depending on your election. If clients are unaware of the date this occurs, they may become concerned seeing a drop in the share price, especially if it's a day where markets are up.  So, when gains are set to be distributed, you’ll want to be aware of the record date which makes you eligible for the distribution, and the date that distribution will be paid. I should also note that dividend distributions may also occur around the same time.

Lindsay: Thank you, Roger. To view when these distributions are scheduled to take place, you can visit the tax planning section of our website.

Read the Full Transcript (PDF)