Although Mutual funds are an excellent way to increase income, they are afflicted by taxes just like any other form of income. With the inclusion of the recent long-term gain tax (LTGC) and the dividend distribution tax (DDT), investors are getting worried about investing in mutual funds. Since the budget this year, many experts have been trying to clear the air around talks of market crashes and the safety of equity mutual funds in these circumstances. Without financial planning, even top mutual funds can lead to a significant tax burden. A number of factors are responsible for deciding the tax efficiency of the best performing mutual funds. These are the frequency of trading activity, the longevity of the fund and the type of distribution made by the mutual fund.
The gains obtained through top mutual funds can either be dividend gains or capital gains. Depending on the duration of the mutual fund, your gains may be taxed as normal income or capital gains. This is important because the tax rate for capital gains is very different from the ordinary income tax rate. Gains from funds that hold assets for more than a year get the capital gain rate instead of the usual income tax rate. The best performing mutual funds increase their tax efficiency by asset turnover, a phenomenon wherein a fund buys and sells securities. These mutual funds are the top mutual funds amidst the new tax inclusions. Funds that are based on a buy and sell strategy bring more dividend gains and are hence tax efficient. Apart from this, experts also say the funds that invest in long-term bonds are safer to invest in, to gain maximum tax benefits. These mutual funds also charge higher amounts each year to maintain, administer and operate the mutual funds.
Experts strongly recommend meticulous financial planning before investing. Since the best performing mutual funds sometimes give gains through dividends, they are subject to normal income tax rates. Hence funds that are not based on dividends are more tax efficient. Investors are concerned with the net returns ultimately. Despite the introduction of the LTGC and the DDT, gains from equity mutual funds will be higher than other alternatives. Because of the 10% rate of DDT on both the types of gains, it is crucial to focus attention on the post-tax rates.
One way to make sure you are tax efficient is to invest in government or municipal bonds. Some of these tax-free funds are the best performing mutual funds. Not only are they exempt from federal taxes but are also relatively safer in terms of security. Good financial planning can increase this security further. If you want to invest in top mutual funds or if you want to realign your objectives with that of a fund, experts suggest financial planning through an advisor. The technicalities of mutual funds can baffle a lay man and you must make sure your investments don’t end up costing you a lot more tax in the long run.