Tax Inefficient Mutual Funds are Good in IRAs

Some mutual funds are very tax efficient. They realize very little in the way of realized capital gains, they pay out very little in dividends, and they have protocols in place to reduce how much buying and selling occurs so those events don’t happen. Some mutual funds, on the other hand, are not very tax efficient and throw off lots, relatively, in realized capital gains, dividends, etc. For those mutual funds that are not efficient but perform well, you can make a home for them in an IRA because the earnings are tax free (temporarily).

Whenever a fund realizes capital gains, dividends, interest, etc; it has to pay out that amount to shareholders if it exceeds the fund’s expense ratio. If the mutual fund has to pay this out, then you’re going to be taxed for it, which is not ideal. Ideally you want the fund to increase in value but not throw off these payments because you want the fund to just keep getting bigger. Kiplingers has a list of four mutual funds that are tax inefficient but otherwise great performers:

• T. Rowe Price Global Stock (PRGSX)
• Pimco StocksPlus D (PSPDX)
• Merger (MERFX)
• Calamos Market Neutral Income A (CVSIX)

So, if you know of a solid fund with weak tax efficiency, don’t dismiss it… consider putting it into your IRA.

Source: Kiplingers