Mutual Fund Notebook: Defer Taxes

N E W  Y O R K, Sept. 14 -- No one can escape taxes. But mutual fund investors may be able to temporarily sidestep them.

Mutual funds are required to pass along dividends and net realized capital gains to shareholders every year. Shareholders must then pay taxes on these distributions.

If you know a fund will be making a large taxable distribution shortly, or if there are telltale signs that a distribution may be in the offing, you may want to wait to buy that fund. Otherwise, you could wind up paying taxes on the gains a fund has made for other shareholders.

“You don’t want to buy into a distribution if you know there’s going to be one,” says Bryan Olson, director at Charles Schwab’s Center for Investment Research.

Won’t Be BlindsidedMost funds make these distributions toward the end of the year, particularly in December. So, if you’re looking to put some money to work in a mutual fund, check to see if a distribution looms. You may decide that the short-term tax hit doesn’t bother you if you plan to be in the fund for the long haul, but at least you won’t be blindsided.

“This is definitely a year to be wary,” warns Morningstar’s Russ Kinnel.

So far this year, the pace of fund distributions well exceeds last year’s, with several funds having passed along enormous capital gains. For example, the Warburg Pincus Japan Growth fund and the Warburg Pincus Japan Small Company fund paid out giant gains. Generally, any distribution that’s more than 15 percent of a fund’s net asset value, or NAV, is considered large. These Warburg