The Huge Tax Bills That Came Out of Nowhere at Vanguard

[question everything]

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.

(snip)

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??”

(snip)

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.

More..

https://www.wsj.com/articles/vanguard-target-retirement-tax-bill-surprise-11642781228 (subscription)

[PoindexterOglethorpe]

1. I've long known that one problem with mutual funds can be

sudden taxes due when they sell stuff and pass the tax liability to the holders. It has happened to me in the past, although not to a degree that was financially painful, lucky me.

I also count myself lucky that I have an excellent financial advisor who monitors such things for me. And for what it's worth, I've never owned any Vanguard. Not because I'm prescient or such a knowing investor myself, but because I trust my advisor to do right by me. And he has. Again, lucky me.

[lastlib]

2. I got a similar whammy from Marsico this fall......

27% of my holding in one LTCGD. It's 60% of my income for the year, all taxable. Ouch.

[Auggie]

3. Sorry, but it sounds like whining

Since when is any firm responsible for taking the extra step in warning investors there will or could be a large tax burden? That's a given for any kind of investment. If in doubt, do your research. There's more than just the prospectus available, you know. It's called Google.

[question everything]

4. I suppose it depends on the nature of the fiduciary

Before Vanguard changed into a "brokerage firm" we had our own contact that we really did not need but who, in November, sent an alert that we needed to pull more to satisfy the RMD.

And, from the same article

A related idea has worked well at Betterment, the online investment-advice company, says Dan Egan, the firm’s head of behavioral science. When clients were about to sell an investment that could trigger taxes, some saw a pop-up prompting them to view their estimated tax liability; others didn’t. Those who saw the pop-up were 15% less likely to enter the sell order.

Little interventions like that could make a big difference to small investors. Those were the people Vanguard’s late founder, John Bogle, championed for decades. In this situation, Vanguard failed them.