Vanguard Mid Cap Index Fund tax distributions

The Vanguard Mid Cap Index Fund is a suitable candidate for placement in taxable accounts.

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.


 * The fund changed index benchmarks from the S&P 400 Index to the MSCI 450 Mid Cap Index on 5/16/2003.
 * The fund added an ETF share class on 1/26/2004.
 * ETF shares dividend annualized in 2004.
 * 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.

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.

Turnover
Table 4.


 * 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.

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 2008 - 2012 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 35%. 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 and at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets. (These tax rates are mandated for 2008-2012.) 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 that are subject to the same 0% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive. Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 0% rate.
 * 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.

Fund 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 institutional creation and redemption activity in the fund.

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 two scenarios: the current favorable tax rate regime (2010-2012) and under a higher tax regime (with dividends taxed at marginal rates and long term capital gains taxed at a maximum 20%). Keep in mind that distributions can also be subject to state and local taxation. The average is based on the results from the period (2004-2010) marked by the qualified dividend tax regime. The fund has realized higher dividend yields since its adoption and tracking of the MSCI benchmark. 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 2.98% short term capital gain distribution and an average 1.61% long term capital gain distribution over the 1998-2002 period.

Table 6.