S&P's new ETF Research Report offeres easy-to-use analysis to help you compare ETFs.
ETF Tax Planning
When you evaluate investments, the return you anticipate and the risks you might face typically deserve the greatest scrutiny. But how much attention should you pay to the taxes that the investment could generate if you owned it or sold it at a profit?
There are smart ways to control the impact of taxes. In fact, tax planning is an essential component in choosing investments in a taxable account. That's because what you owe the government on investment earnings reduces your return and increases the risk of not meeting your goals.
Tax Efficiency
There are smart ways to control the
impact of taxes. One strategy is to concentrate
investments that tend to generate
higher taxes in tax-deferred or tax-free
accounts. In taxable accounts, you might
consider offsetting capital gains by
taking capital losses. And, also in taxable
accounts, you can choose investments
that are tax efficient, which means
they cost you less at tax time than other
investment choices do.
For example, individual stocks and index-based ETFs, as a group, are more tax efficient than:
- Corporate, US Treasury, and most federal agency bonds and the mutual funds that invest in them. That's because federal income taxes on qualifying dividends are taxed at a lower rate — up to 20 percentage points less in the highest tax bracket — than interest income is. (Municipal bond interest is exempt from federal, and sometimes state, income taxes.)
- Real estate investment trusts (REITs). Dividend income from REITS is taxed at the 28% rate rather than at the lower, long-term capital gains rate that applies to qualifying dividends.
- Actively managed mutual funds. Active managers tend to trade securities frequently in an effort to beat their benchmarks. Those trades, the timing of which you can't control, result in taxable capital gains distributions. In addition, some of these transactions produce short-term gains that are taxed at the same rate as your ordinary income.
The Rate of Gain
Through 2010, if you sell shares of most ETFs and have a long-term capital gain, the gain will be taxed at 15% if your regular tax rate is 25% or higher. And you will owe no tax at all on the gain if your regular rate is 10% or 15%. These rates do not apply to ETFs invested in precious metals.
In addition, in a limited number of situations ETFs distribute capital gains, which stocks never do.
Through 2010, if you sell shares of most ETFs and have a long-term capital gain, the gain will be taxed at 15% if your regular tax rate is 25% or higher. And you will owe no tax at all on the gain if your regular rate is 10% or 15%. These rates do not apply to ETFs invested in precious metals.
In addition, in a limited number of situations ETFs distribute capital gains, which stocks never do.
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