Mutual Funds Partially Dodge an Investor Tax Hit
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Tuesday, December 12, 2017

Mutual Funds Partially Dodge an Investor Tax Hit

Mutual funds may have dodged an investor hit from one piece of the Senate's version of the tax reform bill, but there's still plenty for fundsters to keep an eye on as the bill goes through reconciliation.

Paul Schott Stevens, head of the ICI, is pushing back against the FIFO ("first in, first out") change in the Senate version of the bill. Currently when selling their investments, investors (both individuals and mutual funds themselves) can choose which shares they sell, a choice that becomes a critical tax planning tool for investors and their advisors, as well as for mutual fund managers. The Senate proposal would take away that choice for individual investors, though not for funds.

Under the proposal, individual investors would be forced to sell their oldest shares of a stock first, which could mean forcing them to incur higher capital gains taxes. The pain would be slightly lessened for investors in mutual funds, who would have the choice to sell mutual fund shares at the average cost the investor paid. FIFO would make rebalancing more painful for investors with taxable accounts, much to the chagrin of both human financial advisors and roboadvisors. The Wall Street Journal worries that investors may sell shares in the final weeks of 2017 to avoid the FIFO rule. And Stevens points out another danger: investors splintering their accounts to regain tax flexibility.

"Despite the exemption for fund portfolios, the rule imposing FIFO on other instruments will hurt investors and reduce any economic benefit that tax reform might bring," Stevens writes. "And it won't even simplify the tax code — though investors and their advisers already have the experience and the systems they need to manage tax lots, FIFO's incentive to create multiple accounts could make investing and tax preparation even more complex and expensive."

Meanwhile, fundsters with 401(k) recordkeeping or DC I-O businesses may have to worry about defending the popular retirement savings plan from a proposal (not included in either the House or the Senate version of the bill, but of course reconciliation could change all that) to give 401(k) participants easier access to their 401(k) cash to pay down their mortgage or to buy a house for themselves or for their kids, as pointed out by 401kSpecialist.

Yet there's still plenty of potentially good tax reform news for fundsters. The threat of so-called "Rothification" (forcing some or all 401(k) contributions to be after-tax, not before tax, in exchange for eventual withdrawals in retirement being tax-free) seems to have lifted, as detailed by our sister publication, 401kWire. And if the reforms boost stock prices, that will be good for asset managers, too.

"The fund industry is in relatively good shape," one industry insider tells MFWire when considering tax reform as it stands so far. Yet he remains cautious.

"This bill is so complicated and was put together so quickly that there are likely to be issues that nobody's thought very much about," that insider adds. "Thanks to speed, there will be little hiccups where Congress intended one thing but didn't get it right."

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