Vanguard Target Retirement Funds (2030-2050) tax distributions

From Bogleheads
Jump to: navigation, search

The Vanguard Target Retirement Funds (TRFs) are questionable candidates for placement in taxable accounts. The funds are often recommended as a simple indexed one fund solution for implementing a four-fund portfolio consisting of total market domestic stock, international stock, and investment grade U.S bond and international bond funds. ( Inflation-indexed bonds are added to the portfolio mixture during the later stages of a fund's glide path) . TRFs are usually singled out for use in tax deferred (employer provided or individual Traditional IRA accounts) or tax-free (Roth IRA) accounts. The passage of the 2006 Pension Protective Act, establishing target retirement funds as the default option for employer provided contributory retirement plans, has helped increase investor contributions to these funds. Employee contribution allocations to Vanguard TRFs have increased from 2% in 2004 to 20% in 2010. [1] The table below summarizes the fund's relation to a number of tax factors.

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

Qualified dividends: Yes, (avg. 50% to 75% of income)
Treasury interest: Yes, (avg. 2% to 5% of income) [2]
Turnover: Low to Moderate
Stock Migration: Nil
ETF shares : No; but yes for two underlying funds
Foreign tax credit: Yes

Dividends: Higher than stock indexes
Bond dividends subject to taxation at marginal rates
Glide path assures higher bond allocations over time
Historical gains distributions : Recently very low, but dependent on loss carryovers that have been depleted.

Distributions

see Vanguard Target Retirement Funds (2005-2025) Tax Distributions for the additional funds in the TRF series.


Imbox notice.png All Vanguard Target Retirement funds have fiscal years ending on October 31 of each year. Thus a fund's dividend and capital gains distributions for the year include distributions made in December of the prior year.


The following tables provide long term data on each TRF's history of both dividend and capital gains distributions. As fund of funds, TRF's taxable distributions come from two sources:

  1. Income and gains distributions received from the TRF's underlying funds.
  2. The sales which the TRF makes when rebalancing or retargeting the fund.

The breakdown of annual capital gains distributions in the funds can be found on the second and third tabs of Table 10. Target Retirement Funds Capital Gains Distributions, included in the footnotes.

Vanguard Target Retirement 2030 Fund

Table. Vanguard Target Retirement 2030 Fund
Tax Distributions
Year Dividends Short Term Capital Gains [3]


Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return Asset Allocation
2013 2.30% 0.06% 0.00% 66.31% 4.81% 15.05% Stock 77.2%
Bond 22.8%
2012 2.66% 0.07% 0.00% 70.41% 4.96% 21.43% Stock 78.7%
Bond 21.3%
2011 [4] 1.91% 0.15% 0.00% 66.44% 6.10% -0.83% Stock 80.2%
Bond 19.8%
2010 [5] 2.32% 0.00% 0.00% 68.81% 6.21% 10.21% Stock 82.1%
Bond 17.9%
2009 2.92% 0.00% 0.00% 73.42% 3.57% -1.13% Stock 83.6%
Bond 16.4%
2008 2.35% 0.00% 0.00% 70.56% 4.46% -19.43% Stock 86.5%
Bond 14.5%
2007 2.10% 0.00% 0.00% 69.26% 6.04% 17.40% Stock 86.7%
Bond 13.3%
2006 1.81% 0.00% 0.00% 71.24% 3.93% 6.25% Stock 88.0%
Bond 12.0%


Note:

  • For current tax attributes and distributions see Vanguard


Vanguard Target Retirement 2035 Fund

Table. Vanguard Target Retirement 2035 Fund
Tax Distributions
Year Dividends Short Term Capital Gains [3] Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return Asset Allocation
2013 2.33% 0.04% 0.00% 71.94% 3.17% 16.77% Stock 84.6%
Bond 15.4%
2012 2.68% 0.04% 0.00% 76.35% 3.19% 22.98% Stock 86.3%
Bond 13.7%
2011 [4] 1.81% 0.09% 0.29% 74.29% 3.92% -1.55% Stock 87.9%
Bond 12.1%
2010 [5] 2.24% 0.00% 0.00% 78.01% 3.85% 10.24% Stock 89.6%
Bond 10.4%
2009 2.88% 0.00% 0.00% 80.32% 2.35% -1.85% Stock 89.9%
Bond 10.1%
2008 2.28% 0.00% 0.00% 75.86% 3.49% -20.42% Stock 90.00
Bond 10.0%
2007 2.09% 0.00% 0.00% 72.12% 5.60% 17.87% Stock 90.0%
Bond 10.0%
2006 [6] 2.21% 0.00% 0.00% 65.15% 7.38% 9.70% Stock 90.00%
Bond 10.0%
2005 2.33% 0.00% 0.00% 9.39% 13.53% Stock 76.0%
Bond 24.0%
2004 1.70% 0.00% 0.00% 60.52% 4.73% 9.88% Stock 79.9%
Bond 20.1%


Note:

  • For current tax attributes and distributions see Vanguard


Vanguard Target Retirement 2040 Fund

Table. Vanguard Target Retirement 2040 Fund
Tax Distributions
Year Dividends Short Term Capital Gains [3] Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return Asset Allocation
2013 2.36% 0.03% 0.00% 75.45% 2.13% 17.75% Stock 89.9%
Bond 10.1%
2012 2.70% 0.04% 0.00% 78.95% 2.36% 23.43% Stock 89.9%
Bond 10.1%
2011 [4] 1.79% 0.18% 0.00% 76.20% 3.26% -1.87% Stock 89.8%
Bond 10.2%
2010 [5] 2.23% 0.00% 0.00% 78.35% 3.65% 10.38% Stock 90.00%
Bond 10.0%
2009 2.78% 0.00% 0.00% 80.85% 2.24% -1.61% Stock 90.00%
Bond 10.0%
2008 2.24% 0.00% 0.00% 76.51% 3.16% -20.40% Stock 89.9%
Bond 10.1%
2007 1.99% 0.00% 0.00% 74.05% 4.65% 17.83% Stock 90.1%
Bond 9.9%
2006 1.72% 0.00% 0.00% 75.23% 3.11% 5.65% Stock 91.0%
Bond 9.0%


Note:

  • For current tax attributes and distributions see Vanguard


Vanguard Target Retirement 2045 Fund

Table. Vanguard Target Retirement 2045 Fund
Tax Distributions
Year Dividends Short Term Capital Gains [3] Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return Asset Allocation
2013 2.36% 0.03% 0.00% 75.31% 2.14% 17.70% Stock 90.0%
Bond 10.0%
2012 2.70% 0.03% 0.00% 78.93% 2.36% 23.47% Stock 89.8%
Bond 10.2%
2011 [4] 1.79% 0.43% 0.43% 76.09% 3.35% -1.82% Stock 89.8%
Bond 10.2%
2010 [5] 2.24% 0.00% 0.00% 78.29% 3.74% 10.23% Stock 89.8%
Bond 10.2%
2009 2.86% 0.00% 0.00% 80.57% 2.34% -1.77% Stock 90.0%
Bond 10.0%
2008 2.28% 0.00% 0.00% 75.82% 3.47% -20.42% Stock 89.9%
Bond 10.1%
2007 2.08% 0.06% 0.00% 72.09% 5.56% 17.90% Stock 90.0%
Bond 10.0%
2006 [6] 2.03% 0.00% 0.00% 71.38% 5.74% 10.70% Stock 90.0%
Bond 10.0%
2005 2.07% 0.00% 0.00% 5.01% 15.09% Stock 88.0%
Bond 12.0%
2004 1.38% 0.00% 0.00% 72.6% 2.37% 10.53% Stock 90.0%
Bond 10.00%


Note:

  • For current tax attributes and distributions see Vanguard


Vanguard Target Retirement 2050 Fund

Table. Vanguard Target Retirement 2050 Fund
Tax Distributions
Year Dividends Short Term Capital Gains [3] Long Term Capital Gains Qualified Dividends Treasury Dividends FY Annual Return Asset Allocation
2013 2.36% 0.03% 0.00% 75.28% 2.12% 17.74% Stock 90.0%
Bond 10.0%
2012 2.70% 0.03% 0.00% 79.04% 2.34% 23.46% Stock 89.8%
Bond 10.2%
2011 [4] 1.71% 0.05% 0.00% 76.17% 2.50% -1.58% Stock 89.8%
Bond 10.2%
2010 [5] 2.21% 0.00% 0.00% 79.11% 3.64% 10.38% Stock 89.8%
Bond 10.2%
2009 2.74% 0.00% 0.00% 80.79% 2.24% -1.73% Stock 90.0%
Bond 10.0%
2008 2.27% 0.00% 0.00% 76.87% 3.08% -20.41% Stock 89.8%
Bond 10.2%
2007 2.04% 0.00% 0.00% 74.05% 4.65% 17.85% Stock 90.1%
Bond 9.9%
2006 1.88% 0.00% 0.00% 75.23% 3.03% 6.20% Stock 90.0%
Bond 10.0%


Note:

  • For current tax attributes and distributions see Vanguard

Equity: sources of taxable distributions

Equity capital gains

Vanguard Glide Path.gif
Figure 1: Vanguard Target Fund Glide Path

Vanguard TRF's can distribute taxable gains if the underlying funds distribute gains and if the fund itself realizes gains when rebalancing or retargeting a fund's strategic asset allocation. During the fund lifetime period, a TRF has been somewhat tax efficient due to two factors.

  • The underlying equity funds used by a TRF are tax efficient equity index funds that distribute very few (if any) taxable gains. Historically, the funds employed have included the following funds:

In 2010, the regional international index funds were replaced with the Vanguard Total International Stock Index Fund.

  • Fund rebalancing and retargeting is made easier by the steady investor inflows into the portfolios, augmented by employer provided plans use of the funds as default investment options. TRF rebalancing can result in the realization of capital losses and the creation of tax loss carryforwards in the funds. The existence of loss carryforwards has historically resulted in minimal long-term capital gains distributions. Loss carryforwards have been depleted in many of the TRF funds, so these funds can be expected to distribute gains in the future, until capital losses are stockpiled as carryover losses. The sources of fund capital gains and the level of loss carryforwards can be found on the appropriate tabs on Table 8 below.

Equity dividends

The TRF funds pass along the tax-preferenced qualified dividends distributed by the underlying equity index funds. The Total Market Index Fund distributes 100% qualified dividends; International index funds distribute roughly 75% qualified dividends. The actual portion of the TRF dividend that is qualified depends on the strategic equity allocation of the fund, and how this allocation is reduced by the TRF glide path (see Figure 1.) that gradually reduces the equity allocation over time

Foreign tax credit

As of 2010, the Regulated Investment Company Modernization Act of 2010 [7] allows funds of funds to pass on the foreign tax credit from the individual funds to their shareholders.

Bonds: sources of taxable distributions

Bond capital gains

Vanguard TRF's distribute capital gains distributions received from underlying bond funds. Currently these funds include the Vanguard Total Bond Market Index II Fund (since 2009; prior to 2009 the funds invested in the Vanguard Total Bond Market Fund) and the Vanguard Inflation Protected Securities Fund. These bond funds occasionally distribute relatively small short term and long term gains. Future received gains are likely to be offset by fund loss carryforwards.

Bond dividends

Vanguard TRF's receive and distribute taxable dividend income from underlying bond funds. This income is taxable at marginal income tax rates. The funds receive a modest tax preference for dividends received from treasury securities, which are exempt from state and local income tax. The dividend yield of a given TRF is dependent on the fund's strategic asset allocation. Bond allocations grow over time according to the TRF glide path (see Figure 1.)


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 [8] 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 following table examines the tax consequences of holding a TRF in a taxable account. A high equity TRF (the 2045 target fund) and the terminal glide path high income fund (Income target fund) are examined to show the outer bounds of tax costs. (The tables account for the tax on distributions; should the fund be sold at a gain, the capital gains tax would be an added tax cost. Capital gains distributions while holding the funds are negligible.) The tables include the 2010- 2012 tax regime and also show results for the current tax regime introduced in 2013. The tables include a 5% state tax rate (which of course may vary according to state). [9]

In general the following conclusions are prudent.

  1. Investors in high federal tax brackets over 15% would likely be better off avoiding TRF's in taxable accounts if the after tax returns of municipal bonds exceeds the returns of taxable bonds. International stocks held in the taxable account are eligible for the foreign tax credit.
  2. Investors in all tax brackets having sufficient tax advantaged space in retirement accounts would likely be better served by holding higher yielding bond investments in the tax advantaged account, and lower yielding stock investments in the taxable account. International stocks held in the taxable account are eligible for the foreign tax credit.
  3. Investors in the lower tax brackets (10% - 15%) with limited tax advantaged account options may find holding a TRF fund in the taxable account to be acceptable, especially if the investor places a high premium on the simplicity of holding one diversified fund. The tax cost of holding a taxable TRF account will rise somewhat as the glide path transitions to income oriented portfolios. Should an investor's income rise into a higher tax bracket the tax cost will also increase. Likewise, should investment income distribution increase (bond interest and/or stock dividends), the tax bite will be greater. Note that the taxable TRF will also not qualify for a foreign tax credit. An additional factor to consider is the greater flexibility provided by holding separate asset class funds compared to a balanced fund. If you have a balanced fund, you can only sell bonds and stocks simultaneously. If you want to sell only bonds, in order to hold fewer bonds or a different type of bonds, you will have to sell the stock as well and likely pay a capital-gains tax.
Table.

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

See also

References

  1. Target-date fund adoption in 2010
  2. Table.

    (view Google Spreadsheet in browser or download as xls, ods, or pdf)
    source:US government obligations data

  3. 3.0 3.1 3.2 3.3 3.4
    Table.

    (view Google Spreadsheet in browser or download as xls, ods, or pdf)
    source:SEC Edgar Annual Reports and SEC Edgar NSAR reports

  4. 4.0 4.1 4.2 4.3 4.4 The short term gains distribution for FY 2011 resulted from the fund's replacement of the Total Bond Market Index with the Total Bond Market II Index fund. This fund distributed a short term gain in December 2010.
  5. 5.0 5.1 5.2 5.3 5.4 Vanguard press report In 2010 Vanguard made two changes to its series of 12 Target Retirement Funds:
    • The TRFs replaced three component funds that formerly provided international stock exposure (Vanguard European Stock Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund) with a single fund, Vanguard Total International Stock Index Fund.
    • The funds' increased the international equity weighting to about 30% of the overall equity portion, up from approximately 20%.
    • Press release Vanguard also reduced the the minimum investment requirement from $3,000 to $1,000 for its TRFs.
  6. 6.0 6.1 Vanguard press report In 2006 Vanguard changed the asset allocation models of the Target Retirement Funds:
    • The existing funds’ former asset allocation path was modified to provide increased exposure to equities over a longer period of time. The result brought a larger equity allocation of roughly 10 to 20 percentage points, depending on the fund. For example, the Target Retirement 2035 Fund changed its equity allocation to 90% from its former 80%.
    • Vanguard Emerging Markets Stock Index Fund was added to each of the funds (representing roughly 1% to 2.5% of assets), further diversifying their exposure to international markets.
    • Vanguard European Stock Index Fund and Vanguard Pacific Stock Index Fund were added to the Target Retirement 2005 and Income Funds. In aggregate, international stocks represent 10% of the 2005 Fund and 6% of the Income Fund.
  7. Regulated Investment Company Modernization Act of 2010 (see page 12)
  8. 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.
  9. 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.

  10. According to data from the Tax Foundation, state individual marginal tax rates range from 0% to 12%.

External links

Bibliography

White papers