Vanguard Mid Cap Index Fund tax distributions

From Bogleheads
Jump to: navigation, search


The Vanguard Mid Cap Index Fund is a suitable candidate for placement in taxable accounts. 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 low
Qualified dividends: Yes (avg. 86%)
Turnover: Low
ETF shares : Yes

Dividends: Higher than growth indices
Stock Migration: High

The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides the historical distribution of qualified dividends.

The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.

Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.


Distributions

The following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund distributed substantial levels of capital gains during the early years of its existence, a period which coincided with a long bull market. The fund has not distributed a gain since 2002, a period marked by two bear markets and by the presence of an ETF class in the fund. The fund has distributed 89% qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.

Table 2. Vanguard Mid Cap Index Fund Tax Distributions
Year Dividend Investor shares [1] Dividend Admiral shares [1] Dividend ETF shares [1] Short-term Capital Gains [2] Long-term Capital Gains [2][3] Qualified Dividends[4] (FY) Annual Return - Investor [5]
2013 1.16% 1.31% 1.31% 0.00% 0.00% 88.54% 35.00%
2012 1.36% 1.50% 1.50% 0.00% 0.00% 88.81% 15.80%
2011 1.15% 1.29% 1.29% 0.00% 0.00% 93.57% -2.11%
2010 1.25% 1.39% 1.39% 0.00% 0.00% 94.27% 25.46%
2009 1.32% 1.45% 1.45% 0.00% 0.00% 100.00% 40.22%
2008 1.36% 1.47% 1.46% 0.00% 0.00% 81.97% -41.82%
2007 1.30% 1.41% 1.38% 0.00% 0.00% 89.10% 6.02%
2006 1.43% 1.52% 1.52% 0.00% 0.00% 89.33% 13.60%
2005 1.36% 1.45% 1.45% 0.00% 0.00% 13.93%
2004 1.26% 1.35% 1.30% 0.00% 0.00% 86.98% 20.35%
2003 1.20% 1.31% - 0.00% 0.00% n/a 34.14%
2002 0.85% 0.94% - 0.10% 1.02% n/a -14.61%
2001 0.83% 0.86% - 0.39% 1.62% n/a -0.50%
2000 0.90% - - 6.47% 3.42% n/a -18.10%
1999 0.99% - - 7.31% 1.82% n/a 15.32%
1998 1.19% - - 0.65% 0.15% n/a 8.55%

  • The fund changed benchmarks from the MSCI 450 Mid Cap Index to the CRSP US Mid Cap Index on 01/31/2013.
  • The fund added an ETF share class on 1/26/2004.
  • ETF shares dividend annualized in 2004.
  • The fund changed index benchmarks from the S&P 400 Index to the MSCI 450 Mid Cap Index on 5/16/2003.
  • Admiral shares dividend annualized in 2001.
  • Investor shares dividend annualized in 1998.

Accounting data

Reference article: Average net assets

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. [6]

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 third tab on the Table 3. spreadsheet shows the data in percentage of total assets form.

Table 3.

(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.

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

  • Shareholder turnover in 2010 is magnified by investor share to admiral share conversion due to the liberalization of the Admiral share program (minimum investment lowered to $10,000).
  • Shareholder turnover in 2007 is magnified by admiral share to signal share conversion due to policy change in Vanguard employer provided plans (the use of signal shares).
  • Shareholder turnover in 2000 is magnified by investor share to admiral share conversion due to creation of admiral shares.



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 [7] 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.


Tax analysis

The annual fund accounting figures show that the Vanguard Mid Cap Index fund, since its adoption of the MSCI mid cap index as its tracking index, has provided lower turnover ratios inhabiting a range between 16% to 24%. These ratios suggest a holding period for the portfolio stock holdings of between 4 to 6 years. This moderate turnover can be attributed to the fact that stock migration out of a mid cap blend index can come in the following dimensions:

  1. An individual company becomes relatively larger and migrates to a large cap index;
  2. An individual company becomes relatively smaller and migrates to a small cap index;
  3. An individual company is bought out or merged with a second company.

Shareholders have made net purchases of fund share since the fund's inception. Shareholder turnover, revealed in the Redemptions/Average Net Assets (R/ANA) metric, shows that shareholders, in years not affected by large shareclass conversion activity, have turned over their fund holdings at rates ranging from 18%-40%, suggesting holding periods of between 2 to 5 years. A considerable portion of fund assets is held in the ETF share class. The ETF R/ANA metric reveals substantial institutional creation and redemption activity in the fund. [8]

A look at realized net gains/losses shows that the fund has, since the introduction of the ETF shareclass, realized net losses in each of the past five years (see the second tab, tax attributes in Table 3 above). These losses produce an ever increasing loss carryforward which can used to offset future realized gains.

The following table presents the federal tax cost on the fund's historical distributions (see second tab, table 6.) under the current tax regime (with dividends taxed at and long term capital gains taxed at tax rates of 0%, 15%, or 20% depending on marginal tax rate, and an additional 3.8% ACA Net Investment Income tax assessed at higher tax rates). Keep in mind that distributions can also be subject to state and local taxation, with marginal rates ranging from 0% to 12% (an average 5% state tax rate will add an approximate 0.07% to the annual tax cost of holding the fund.) The average is based on the results from 2004-2013, the period marked by the qualified dividend tax regime. The fund has realized higher dividend yields since it began tracking the MSCI Mid Cap Index in 2003. With no loss carryforwards and the higher turnover rates experienced by the fund's prior tracking index (S&P 400 index} the fund distributed an average per annum 2.49% short term capital gain and an average per annum 1.34% long term capital gain over the 1998-2003 period.

The table does not include the capital gains cost associated with selling the fund at a gain. [9]

Table 6.

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

See also

References

  1. 1.0 1.1 1.2 Dividend data is derived from the Complete filings: N-CSR reports back to 2003; N-30D reports back to 1994
  2. 2.0 2.1 Capital Gains are derived from annual reports, and are calculated by dividing the dollar amount capital gain distribution by the average net assets of the fund, derived from NSAR reports
  3. Table 7.

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

  4. Data derived from Vanguard site.
  5. data derived from annual reports.
  6. Larry E. Swedroe, What Wall Street Doesn’t Want You To Know, 2001, pp.227-28. ISBN 0312335725
  7. 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.
  8. 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.

  9. Because ETF share classes reduce transaction costs and bring tax benefits to the fund portfolio regardless of share class turnover (which can be quite high) we provide separate R/ANA and R/S ratios for the ETFs. We must approximate the average net asset figure for ETFs. One should also note that Vanguard includes share class conversions (investor/admiral) in the sales and redemptions totals for the fund. Vanguard does not quantify conversions. These non-transaction conversions inflate the reported shareholder ratios.
  10. This table indicates the additional cost for the capital-gains tax when you sell, assuming that you pay taxes on the distribution and reinvest the after-tax portion of the distribution; since it is a one-time cost, the effect is annualized. For example, if you hold an investment for 30 years and lose 10% to taxes when you sell, that is equivalent to losing 0.35% every year. Thus, if you sell the fund, your cost will be the sum of the Table 6 and Table 8 costs. However, you would not pay the Table 8 cost on any stock which you either leave to your heirs or donate to charity, and thus may not pay that cost on your full investment. In particular, you might estimate your total tax cost by using the low-return line in Table 8; if stock returns are high, you will have a large taxable account and will reduce the tax cost by taking longer to deplete it or by not spending it all during your lifetime. Taxes are computed at a tax rate of 15% on long-term gains (except in the "rate rises to 20% column", which applies if that tax reduction is allowed to expire), and on qualified dividends (except in the "no QDI" column, which applies if the tax reduction on qualified dividends expires and the rate is 35%). Although not tabulated, keep in mind that investors in the lower tax brackets (15% or lower) pay lower federal tax rates on investment income for the period 2003 - 2013, and reap higher after-tax returns, outside of tax-exempt municipal bonds, in all asset classes.
    Table 8. Additional hypothetical tax costs (after taxable funds are sold)
    Fund Pre-tax Returns Distributions Tax Cost Annualized cost over 10 years Annualized cost over 20 years Annualized cost over 30 years 30-year cost if CG tax rate rises to 20%
    Any bond any all any 0.00% 0.00% 0.00% 0.00%
    Tax-efficient stock, low returns 5.00% 2.00% 0.30% 0.36% 0.30% 0.25% 0.33%
    Tax-efficient stock, medium returns 8.00% 2.00% 0.30% 0.63% 0.47% 0.37% 0.50%
    Tax-efficient stock, high returns 11.00% 2.00% 0.30% 0.84% 0.58% 0.43% 0.58%
    Tax-inefficient stock, low returns 5.00% 4.00% 1.00% 0.12% 0.10% 0.09% 0.12%
    Tax-inefficient stock, medium returns 8.00% 4.00% 1.00% 0.43% 0.33% 0.26% 0.35%
    Tax-inefficient stock, high returns 11.00% 4.00% 1.00% 0.66% 0.47% 0.35% 0.47%

External links