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If you own mutual funds, year-end payouts can trigger a surprise tax bill — even when you haven’t sold the underlying investment. But some lawmakers want to change that.
Sen. John Cornyn, R-Texas, this week introduced a bill, known as the Generate Retirement Ownership Through Long-Term Holding, or GROWTH, Act. If enacted, the bill would defer reinvested mutual fund capital gains taxes until investors sell their shares.
Bipartisan House lawmakers introduced a similar bill in March.
Why mutual funds incur capital gains tax
When you own mutual funds in a pre-tax 401(k) or individual retirement account, growth is tax-deferred. But if you hold assets in a brokerage account, capital gains distributions and dividends incur yearly taxes.
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Depending on performance, some mutual funds can spit off substantial gains during the fourth quarter. In 2024, some paid double-digit distributions, Morningstar estimated.
These payouts are subject to long-term capital gains taxes of 0%, 15% or 20%, depending on your taxable income. Some higher earners also pay an extra 3.8% surcharge on investment earnings.
About $7 trillion of long-term mutual fund assets held outside of retirement accounts could be impacted by the legislation, according to the Investment Company Institute, which represents the asset management industry.
Bill would ‘provide parity’ for mutual funds
In a statement Wednesday, Cornyn described the mutual fund proposal as a “no-brainer” that would “help provide parity with other investment options.”
If enacted, the proposal would “incentivize Americans to save and invest for their long-term goals” without the stress of an “unexpected tax bill,” Eric Pan, president and CEO of the Investment Company Institute, said in a statement following the bill’s introduction.
However, it’s unclear whether the bill will advance amid competing priorities. Lawmakers are wrestling over President Donald Trump’s multi-trillion-dollar tax and spending package, which passed in the House on Thursday, and could face hurdles in the Senate.
The U.S. Department of the Treasury has also asked Congress to raise the debt ceiling before August to avert a government shutdown.
Switch to exchange-traded funds
While deferring yearly taxes could benefit some investors, you could also make portfolio changes, financial experts say.
You can avoid mutual fund payouts by switching to similar exchange-traded funds, or ETFs, which typically disburse less income, Tommy Lucas, a certified financial planner and enrolled agent at Moisand Fitzgerald Tamayo in Orlando, Florida, previously told CNBC.
Of course, the trade could also trigger taxes if the mutual fund has embedded gains, which may require some planning, he said.
Alternatively, investors could opt to keep mutual funds in tax-deferred accounts, such as pre-tax 401(k)s or IRAs.
