Vanguard Inflation Protected Securities Fund tax distributions



Distributions

 * In July 2007, the board of trustees approved a change in the fund’s fiscal year-end from January 31 to December 31. This change was effected through a tax-free reorganization of the fund from a series of Vanguard Fixed Income Securities Funds to a series of Vanguard Bond Index Funds. The change had no effect on the fund’s financial position or results of operations. The change is reflected in the two entries for the year 2007 (from Jan. 31 2006 to Jan 31. 2007) and (Jan. 31 2007 to Dec. 31 2007).
 * 2006 Admiral class dividend annualized.
 * 2001 Investor class dividend annualized.
 * In July 2007, the board of trustees approved a change in the fund’s fiscal year-end from January 31 to December 31. This change was effected through a tax-free reorganization of the fund from a series of Vanguard Fixed Income Securities Funds to a series of Vanguard Bond Index Funds. The change had no effect on the fund’s financial position or results of operations. The change is reflected in the two entries for the year 2007 (from Jan. 31 2006 to Jan 31. 2007) and (Jan. 31 2007 to Dec. 31 2007).
 * 2001 Investor class 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. Bond funds have higher turnover ratios than stock funds, since the bond manager must buy and sell bonds as they mature, and as the manager maintains the maturity and duration structure of the portfolio. The gains or losses on a bond are primarily determined by changes in interest rates, and in some instances, credit quality.

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 bonds at different prices. The manager can select high basis securities when forced to sell a bond (this may realize a loss). The manager can also select low basis securities when redeeming a bond 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.

Table 3.

Turnover
Table 4.

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. Bond fund interest income subject to federal taxation is taxed at marginal tax rates. 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. Treasury bond interest is usually not taxed at the state and local levels.
 * 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 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 long term capital gains taxed at a maximum 20%). Keep in mind that the coupon and inflation adjusted distributions are not subject to state and local taxation if the fund is  held in the taxable account. The third tab provides a breakdown of the yearly division of the fund distribution between coupon yield (average 2.17%) and inflation adjusted principal (average 2.23%). The averages are based on the results from the 2001-2010 life of the fund. One should note that the coupon yield of the fund is presently lower than the long term average, and that the fund's tax liability will increase or fall depending on the rise or fall of future inflation adjustments.

Table 6.