The Huge Tax Bills That Came Out of Nowhere at Vanguard [View all]
It’s easy for a small investor to make big mistakes. It would be even easier for giant investment firms to help prevent them—but, sadly, the asset-management industry seems to have other priorities. Just look at what happened last month to some investors in Vanguard’s Target Retirement funds. They got whacked with huge capital-gains distributions. Those payouts triggered painful tax bills they could easily have avoided if Vanguard had simply warned them not to hold these funds outside of a tax-advantaged retirement account.
Like many investment firms, Vanguard offers target-date funds: bundles of stocks, bonds and cash that automatically become more conservative as investors approach their retirement date. These funds are tailored for investors in 401(k)s or other retirement plans where taxes are deferred. So target funds aren’t managed to minimize dividends or capital gains. Hold them in a taxable account instead of a retirement plan, and you will owe taxes on those payouts—sometimes much more than you would in other types of funds.
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Vanguard’s Target Retirement 2035 and Target Retirement 2040 funds, for example, distributed approximately 15% of their total assets as capital gains—which are taxable outside of retirement accounts. Fury erupted on Bogleheads.org, a website popular among Vanguard investors. One investor posted there: “I think I’m screwed by Vanguard resulting in an enormous tax bill…. I feel that Vanguard guided me down this path which is frustrating.”
In the Bogleheads area on Reddit, another online forum, an investor posting as “Sitting-Hawk” said he received about $550,000 in distributions in Vanguard’s Target Retirement 2035 fund. So he owes 23.8% in federal tax and 4.95% in Illinois state tax—all told, more than $150,000. “HOW,” he asked in capital letters, “COULD VANGUARD LET THIS HAPPEN??”
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Spokeswoman Carolyn Wegemann said that because the Target Retirement approach seeks to reduce risk over time by automatically trimming stock positions, “these funds are best served in a tax-deferred account.” Yet nowhere on the funds’ main pages at Vanguard.com does the firm tell investors that the funds aren’t ideal for taxable accounts. The summary prospectus, a document almost no one reads, intones on page 10 of 14 that “distributions may be taxable as ordinary income or capital gain.” Vanguard is far from alone. Few leading asset managers clearly and simply state which of their funds should be held in a taxable account.
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https://www.wsj.com/articles/vanguard-target-retirement-tax-bill-surprise-11642781228 (subscription)
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