Do I Ihave to pay tax on profits I make in the stock market?
（I have an IRA in the stock market and i only pay tax when I withdraw money. I plan to leave that account as it is.
I may open a small separate mutual fund and I wonder what the tax will be. I am putting 5k into it and not planning to withdraw any money for 5-10 years.）
Answer ：
Separate taxable investment accounts are taxed as capital gains or income is realized.
The most important tax information of mutual fund products that investors needs to be aware of is that tax is applied at the fund level, and then passed on to the investors of the fund. This means that the trading activities of the fund determine the tax liability, which is then shared on a pro-rated base among all the investors of the fund.
The effect is that even though you might not have engaged in any taxable transactions in some particular period, you might still be liable to pay your share of the fund’s tax if the fund has engaged in taxable transactions. In other words, if your fund went down 20% over the year, you could still be liable for taxes even though you lost money. If mutual fund is held in a taxable account, the individual investor typically don’t know what the tax is until they get the bill.
Because of the taxable transactions of a mutual fund is at the discretion of the fund manager, and not the investor, most people only hold mutual fund products in taxed deferred accounts such as IRA or 401k’s, thus bypassing the tax issue altogether. Otherwise, mutual funds are considered extremely tax-inefficient investment vehicles when held in taxable accounts.
For taxable accounts, I use ETFs instead. Exchange Traded Funds often offer the same diversification benefits of mutual funds, but due to a particularly feature of the product (which is too complicated and pointless unless you work in finance), they are taxed and traded on the open market just like common stocks, i.e. I’m taxed only when I realize capital gains or receive dividend. Just like common stocks, almost all ETF products can be accessed from any brokerage account.
Some popular ETFs include the NASDAQ 100 (QQQQ) or SP500 index (SPY). A good resource is “ETFconnect.com”
ETF is part of a larger family of investment products know commonly as “open-ended funds” (not the same as “close-end funds”, which is a very different animal altogether). ETFconnect.com refers to true ETF as “Index Exchange-Traded Funds”
Posted: July 29th, 2010 under US Stock Market.
Tags: pay tax on profits, Stock market