Vanguard Balanced Index Fund tax distributions

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The Vanguard Balanced Index Fund is a questionable candidate for placement in taxable accounts. The fund represents a commonly recommended and held investment allocation used by institutional investors consisting of 60% equity stock investments and 40% bond securities. The fund invests its stocks in a US total stock market index portfolio (CRSP Total Market Index) and its bonds in a US total bond market index portfolio (Barclays Capital U.S. Aggregate Float Adjusted Index). The table below summarizes the fund's relation to a number of tax factors.


Table 1. Summary
Fund Distributions.jpg Favorable tax factors Fund Distributions.jpg Unfavorable tax factors

Historical gains distributions : Recently very low
Qualified dividends: Yes, (avg. 40% of income distributions)
Treasury interest: Yes, (avg. 13% of income distributions) [1]
Turnover: Moderate
Stock Migration: Nil

ETF shares : No
Dividends: Higher than stock indexes
Bond dividends subject to taxation at marginal rates

Distributions

The following table provides long term data on the Vanguard Balanced Index Fund's history of dividend and capital gains distributions. Qualified dividend data (with the exception of unavailable figures for fiscal year 2005) are provided, as are data on the percentage of treasury and government security dividends (which are exempt from state and local income tax in most states). Vanguard provides government obligations data back to 2004.


Table 2. Vanguard Balanced Index Fund Tax Distributions
Year Dividends- Investor shares Dividends- Admiral shares Short Term Capital Gains [2] Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return- Investor shares
2013 1.84% 1.99% 0.00% 0.00% 55.98% 11.01% 17.91%
2012 2.13% 2.27% 0.00% 0.00% 57.02% 10.68% 11.33%
2011 2.22% 2.36% 0.00% 0.00% 47.13% 13.50% 4.14%
2010 2.38% 2.52% 0.00% 0.00% 45.30% 13.10% 13.13%
2009 2.91% 3.02% 0.00% 0.00% 44.88% 9.21% 20.05%
2008 3.11% 3.20% 0.00% 0.00% 38.76% 11.40% -22.21%
2007 2.99% 3.08% 0.00% 0.00% 33.50% 15.92% 6.16%
2006 2.93% 3.02% 0.00% 0.00% 33.57% 17.02% 11.02%
2005 2.69% 2.78% 0.00% 0.00% 15.66% 4.65%
2004 2.66% 2.75% 0.00% 0.00% 38.24% 12.64% 9.33%
2003 2.68% 2.74% 0.00% 0.00% n/a 19.87%
2002 3.14% 3.22% 0.00% 0.00% n/a -9.52%
2001 3.26% 3.32% 0.03% 0.11% n/a -3.02%
2000 3.30% 3.49% 0.20% 0.35% n/a -2.04%
1999 3.18% - 0.09% 0.65% n/a 13.61%
1998 3.29% - 0.37% 0.51% n/a 17.85%
1997 3.56% - 0.42% 0.55% n/a 22.24%
1996 3.69% - 0.12% 0.85% n/a 13.95%
1995 3.85% - 0.00% 0.46% n/a 28.64%
1994 3.86% - 0.00% 0.00% n/a -1.56%
1993 3.53% - 0.00% 0.39% n/a 10.00%
1992 3.76% - 0.00% 0.00% n/a

  • FY 2013- Fund transitioned to CRSP Total Market index on January 15, 2013
  • FY 2012- Fund completed merging Vanguard Asset Allocation Fund assets on February 12, 2012
  • FY 2000- Admiral shares dividend annualized

Accounting data

The accounting figures and associated ratios (tables 3 and 4) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:

Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:

  1. Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.)
  2. A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains. [3]

The level of unrealized gains and carryover realized losses in a fund: A fund which defers gains realization accumulates unrealized appreciation, which when distributed, will be taxed; thus the unrealized gain/loss figure shows the potential gain (or loss) that would be realized if the portfolio was to be entirely liquidated. Any loss carryovers a fund possesses can be used to offset future realized gains (carryovers have an eight year expiration period). The second tab on the Table 3. spreadsheet shows the data in percentage of total assets form.

Table 3. [4]

(view Google Spreadsheet in browser or download as xls, ods, or pdf)



Definition of terms

Net sales/redemptions: This statistic reveals whether investors are net buyers or sellers of the fund.

Realized gain/loss: A realized capital gain/loss is an increase (or decrease) in the value of a security that is "real" because the security has been sold by the portfolio manager. The capital gains/losses are "realized" by the fund, and any distributions to the shareholder as a result of realized gains (adjusted for any realized losses) are taxable during the tax year in which the security was sold. Realized losses can be used to offset realized gains in an attempt to reduce taxable gains. If realized losses are higher than realized gains, a fund can "carry forward" these excess losses to offset future gains. In-kind redemption gains are included as gains in this statistic. As these gains are not taxable, they must be deducted from the realized/gain tally to reflect the net gain/loss for the year. (see tax attributes for the net gain computation).

Distributed gains: A net realized gain will be distributed to shareholders as a capital gains distribution.

Unrealized gain/loss: An unrealized capital gain/loss (also called a "paper profit or loss") is an increase (or decrease) in the value of a security that isn't "real" because the security hasn't been sold. When a portfolio manager sells a security, however, the capital gains/losses become "realized" by the fund, and any realized gains (net of any losses) are taxable during the tax year in which the security was sold. Funds with low turnover rates, such as index funds, tend to have more unrealized gains than actively managed funds and are less likely to pass taxable gains on to investors. A fund's unrealized appreciation or depreciation figures are valuable because they can give an idea of whether a fund would need to distribute any gains if all of its securities were sold. Such information may help you determine your potential exposure to taxable distributions. This statistic is volatile, and will increase or decrease depending on market returns.

Loss carryforward: Realized losses can be “carried forward”, over a set span of years, to offset any future net realized gains.

In-kind redemptions: Instead of selling securities, a portfolio manager may elect to distribute securities in-kind to redeeming shareholders. Unlike a sale, an in-kind transfer is not taxable. This technique is frequently used in the ETF creation/redemption process. For institutional redemptions, a portfolio manager can select low-basis securities to transfer (removing the embedded tax liability) from the portfolio.

Turnover

Reference article: Average net assets

Table 4. [5]

(view Google Spreadsheet in browser or download as xls, ods, or pdf)


Definition of terms

Average net assets: Average net assets are derived from NSAR reports from the EDGAR database.

Redemptions: The dollar amount of fund shares sold by shareholders.

Sales: The dollar amount of fund shares bought by shareholders.

Turnover: The rate at which the fund manager sells securities within the portfolio. The reciprocal of this number reflects the average holding period of the portfolio. Low turnover often results in low capital gains realization.

R/ANA: The redemptions/average net assets (R/ANA) ratio reflects how fund shareholders are turning over their holdings in the fund. It is analogous to the investment manager's turnover ratio.

R/S: The redemption/sales ratio (R/S) illustrates whether investors are net buyers or sellers of the fund. A ratio of less than 1 means that investors are net purchasers of the fund. A ratio more than one means investors are net sellers of the fund. The R/ANA and R/S ratios, viewed together, can signal market timing activity within a fund. For example a fund showing an R/ANA ratio of 400% and an R/S ratio of 1 (equal buys and sells) is likely being market timed by fund shareholders.

Tax rates

Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2013 onward are outlined below. Keep in mind that investment income may also be subject to state and local taxation.

  1. Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 39.6%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.
  2. Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets, at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets, and at 20% in the 39,6% tax bracket. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
  3. Qualified dividends are the ordinary dividends [6] that are subject to the same tax rate that applies to long-term capital gains. They should be shown in box 1b of the Form 1099-DIV you receive.
  4. When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.
  5. The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.
Federal Income Tax Rates in 2013
Taxable income up to this level Tax rate
Single Married filing joint Head of Household Ordinary income Long-term gains and qualified dividends
$8,925 $17,850 $12,750 10% 0%
$36,250 $72,500 $48,600 15% 0%
$87,850 $146,400 $125,450 25% 15%
$183,250 $223,050 $203,150 28% 15%
$398,350 $398,350 $398,350 33% 15%
$400,000 $450,000 $425,000 35% 15%
above above above 39.6% 20%

In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level.


Federal Income Tax Rates in 2012
Taxable income up to this level Tax rate
Single Married filing joint Head of Household Ordinary income Long-term gains and qualified dividends
$8,700 $17,400 $12,400 10% 0%
$35,350 $70,700 $47,350 15% 0%
$85,650 $142,700 $122,300 25% 15%
$178,650 $217,450 $198,050 28% 15%
$388,350 $388,350 $388,350 33% 15%
above above above 35% 15%

In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level.


See also

References

  1. source:US government obligations data
  2. Table 6.

    Data sources:SEC Edgar Annual Reports (2003 forwards);(1993-2003); and NSAR reports

    (view Google Spreadsheet in browser or download as xls, ods, or pdf)

  3. Larry E. Swedroe, What Wall Street Doesn’t Want You To Know, 2001, pp.227-28. ISBN 0312335725
  4. Data sources EDGAR filings: N-CSR reports back to 2003 ; N-30D reports back to 1993
  5. Data sources Average Net Assets: [NSAR reports EDGAR NSAR filings] Turnover statistics:EDGAR filings: N-CSR reports back to 2003 ; N-30D reports back to 1993
  6. Fairmark says:

    A portion of your ordinary dividend may be nonqualified because it can include items like these:

    • Taxable interest. When a mutual fund receives taxable interest, the income gets paid out as a dividend. It's a dividend when it goes out of the mutual fund, but it wasn't a dividend when it came into the mutual fund, so it can't be a qualified dividend.
    • Nonqualified dividends. Your mutual fund may receive dividends that are nonqualified. For example, the mutual fund may sell shares just 35 days after buying them, but after receiving a dividend. The mutual fund has to hold the shares at least 61 days to have a qualified dividend. Any amount the mutual fund receives as a nonqualified dividend gets paid to you as a nonqualified dividend.
    • Short-term capital gain. When a mutual fund has a short-term capital gain, it pays this amount to the mutual fund shareholders as an ordinary dividend.
    • Holding mutual fund shares less than 61 days. You should also be aware that any dividend you receive on mutual fund shares held less than 61 days is a nonqualified dividend, even if the mutual fund reports that amount to you as a qualified dividend. You don't have to buy the shares 61 days before the dividend is paid, but the total amount of time you hold the shares (including time before and after the dividend) has to be at least 61 days.
  7. Almost all of the dividends distributed by Equity REITS come in the form of non-qualified dividends. Non-qualified dividends are taxed at marginal income tax rates.

External links

  • Current tax attributes and distributions: Vanguard