Mutual funds are popular with young couples because they offer diversified portfolios run by professional investors with a minimal initial investment. While mutual funds are designed for long-term investment, there may come a time when you want to pick your own investments, switch to a better fund or simply withdraw the money for unexpected expenses. Before you liquidate your mutual fund, pay attention to the possible costs involved, including taxes, to avoid any negative financial surprises.
Traditionally, mutual funds were sold with an upfront sales charge, with no additional cost to sell the fund. More recently, no-load funds have proliferated in the marketplace, charging investors no commission at all on both purchases and sales. If you purchased a type of share class known as a B share, you may have to pay a sales charge if you liquidate your mutual fund. B shares typically charge a fee on sales that declines depending on the time you have owned the fund. Sales charges in the first year after purchasing the fund are usually 5 percent, declining to zero after six or more years.
Mutual funds are assets that are subject to capital gains taxes just as stocks are. If you liquidate your mutual fund at a gain, you will have to pay capital gains tax on that profit. If you intend to sell your fund to pay off expenses, set aside some of the sales proceeds to pay the tax bill that will be awaiting you when you next file your taxes. You may also owe capital gains taxes even if you sell your mutual fund at a loss. All funds are required by law to distribute any capital gains they earn to shareholders, and in some situations even a fund that is down in value can make a taxable capital gains distribution to shareholders. You will receive a Form 1099 at the end of the year from your fund company listing any capital gains distributions.
A "wash sale" occurs if you sell an investment and purchase the same or a "substantially identical" investment within 30 days before or after the sale. For example, if you sell your mutual fund to buy Christmas presents and then repurchase the fund after the start of the new year, you might be in violation of the wash sale rule, which will prevent you from deducting any losses on the sale of the fund from your taxes.
If you want to liquidate your mutual fund simply because you don't like the fund anymore, an exchange may be a better option for you. In most fund companies, you can exchange your fund into any other fund the company offers for no sales charge, even if you would normally have to pay a sales charge if you sold the fund. For example, you can exchange B shares of Fund ABC into B shares of Fund XYZ at the same company and not incur any back-end sales charges from selling Fund ABC. You will still be liable for any tax consequences on the fund exchange, just as if you sold the initial fund.
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