Vanguard Target Funds - Large Cap Gains Distribution?

[ERD50]

I swear I read about this earlier, but can't find the thread. But today, DD's tax form came to our home, and I see this large cap gains for her VG Target fund. Arghhhh! She didn't sell anything!

Now I have to explain this to her. I figured a target fund was simple, buy and forget, let them rebalance. But I also had this niggling feeling that I really like holding 2 funds for flexibility.

So here's an explanation, VG dropped the requirement to get into their lower fee institutional fund from $100M to $5M. Many investors and smaller institutions moved from their higher fee fund to this lower fee fund. VG had to buy/sell to accommodate this.

Her fund (2050) paid out 9.71% in cap gains. I'm not even sure it is auto reinvested, so I'll need to look at that.

VG dropped the ball on this. I'm moving everything to ETFs.


https://www.mymoneyblog.com/vanguard-target-retirement-funds-nav-drop-cap-gains-distribution.html

-ERD50

 

[ERD50]

OK, it was discussed in a post in a related topic, but I missed it because it wasn't the exact topic of the OP.So when I read the OP, I said "That's not it!". Discussed here:

https://www.early-retirement.org/fo...ital-gains-in-taxable-112672.html#post2722411

-ERD50

 

[ERD50]

Update - the distribution was made 12/29 - so too late to do any other tax moves, even if you had some control in some other area. Really sucks. And it did get auto-reinvested.

And she's still got a ~12% gain in the fund. Hmmm, I suppose all we can do right now is direct the reinvestment to an ETF. And since the fund dropped after the distribution, and has dropped a bit more since then (but still a gain on the old shares), she could sell the distributed shares at a loss, then sell enough of the older shares to net zero gains. Would at least get her out of some of it.

VG really screwed this up!

-ERD50

 

[homestead]

Yep I got bit a few years ago and switched to
Vanguard Tax-Managed Balanced Adm VTMFX
for my after-tax account.
So far no capital gains only quarterly dividends.

 

[tulak]

I don’t think there are target retirement ETFs?

Or are you moving her to separate index ETFs?

 

[ERD50]

I don’t think there are target retirement ETFs?

Or are you moving her to separate index ETFs?

Right, it would need to be something like VTI and BND. No big deal, only a smidge more complex than the target fund.

-ERD50

 

[RetiredAt55.5]

I swear I read about this earlier, but can't find the thread. But today, DD's tax form came to our home, and I see this large cap gains for her VG Target fund. Arghhhh! She didn't sell anything!

Now I have to explain this to her. I figured a target fund was simple, buy and forget, let them rebalance. But I also had this niggling feeling that I really like holding 2 funds for flexibility.

So here's an explanation, VG dropped the requirement to get into their lower fee institutional fund from $100M to $5M. Many investors and smaller institutions moved from their higher fee fund to this lower fee fund. VG had to buy/sell to accommodate this.

Her fund (2050) paid out 9.71% in cap gains. I'm not even sure it is auto reinvested, so I'll need to look at that.

VG dropped the ball on this. I'm moving everything to ETFs.


https://www.mymoneyblog.com/vanguard-target-retirement-funds-nav-drop-cap-gains-distribution.html

-ERD50

Another issue, as the article mentions, is that even Vanguard doesn't recommend using target funds in a taxable account. There is a cost for this automatic rebalancing - less tax efficiency.

A bond ETF is still going to generate dividends, so that would be best in a tax deferred account so DD isn't paying taxes every year on those dividends. Any rebalancing can be done tax free using the tax deferred accounts.

 

[Dabbler]

I swear I read about this earlier, but can't find the thread. But today, DD's tax form came to our home, and I see this large cap gains for her VG Target fund. Arghhhh! She didn't sell anything!

Now I have to explain this to her. I figured a target fund was simple, buy and forget, let them rebalance. But I also had this niggling feeling that I really like holding 2 funds for flexibility.

So here's an explanation, VG dropped the requirement to get into their lower fee institutional fund from $100M to $5M. Many investors and smaller institutions moved from their higher fee fund to this lower fee fund. VG had to buy/sell to accommodate this.

Her fund (2050) paid out 9.71% in cap gains. I'm not even sure it is auto reinvested, so I'll need to look at that.

VG dropped the ball on this. I'm moving everything to ETFs.


https://www.mymoneyblog.com/vanguard-target-retirement-funds-nav-drop-cap-gains-distribution.html

-ERD50

The Wall Street Journal's Jason Zweig also has a thorough explanation of what happened in his Jan 21 Intelligent Investor column, which can be read here:


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

 

[marinauser]

Before there is too much panic, does she even owe any taxes on the capital gains? I suspect that most of the distributed gain was classified as long term. If she had no other capital gains then isn't about $40,000 at a 0% tax rate if she is single? Also, anyone that owns funds of any type, including etfs should start watching at the beginniing of November for investment companies to start releasing estimated capital gain numbers to use for tax planning.

 

[ERD50]

Before there is too much panic, does she even owe any taxes on the capital gains? I suspect that most of the distributed gain was classified as long term. If she had no other capital gains then isn't about $40,000 at a 0% tax rate if she is single? Also, anyone that owns funds of any type, including etfs should start watching at the beginniing of November for investment companies to start releasing estimated capital gain numbers to use for tax planning.

You are right, I need to check. Being single with a nurses income and some overtime and shift change pay (she got almost double to cover nights for 6 weeks), I was thinking she'd hit the 15% pretty fast, but maybe not.

Good point about checking the cap gains estimates, I didn't really think about that as I have moved almost all of my taxable to ETFs. But she only has her W-2 income, not really anything she could do about it. No loss harvesting or adjusting Roth conversions like I could do.

edit/update: I did a rough guess on her W-2, and with the divs from that fund, she's already in the 22% bracket, and with/without that distribution, it all gets taxed at 15%.

-ERD50

 

[SecondCor521]

Before there is too much panic, does she even owe any taxes on the capital gains? I suspect that most of the distributed gain was classified as long term. If she had no other capital gains then isn't about $40,000 at a 0% tax rate if she is single? Also, anyone that owns funds of any type, including etfs should start watching at the beginning of November for investment companies to start releasing estimated capital gain numbers to use for tax planning.

The $40K number and 0% tax would only be the case to the extent that she doesn't have ordinary income. As ERD50 mentions in the post above, she does have W-2 income which uses up some or most of that $40K. The capital gains "stack" on top of ordinary income.

 

[Alan]

The Wall Street Journal's Jason Zweig also has a thorough explanation of what happened in his Jan 21 Intelligent Investor column, which can be read here:


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

That’s behind a firewall, at least for me it is. Any chance of a précis?

 

[Chuckanut]

That’s behind a firewall, at least for me it is. Any chance of a précis?

Basically, some investors are complaining that Vanguard (and other mutual fund companies) should have had a clear warning message that Target Date funds should only be use in tax advantaged accounts.

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??”

“Sitting-Hawk,” who asked me not to disclose his real name, says he put about $1.9 million into the fund in a taxable account in 2015 after he maxed out contributions to his tax-deferred funds. He added more savings; by last year, he had about $3.6 million in taxable money in the fund.
“I didn’t want to be that guy who’s constantly trading,” he says. “I just wanted to set it and forget it and have some peace of mind instead of messing around with it every couple of days.”
“It sucks that this had to happen,” he says.
It happened because big clients left little ones holding the bag. Vanguard’s target funds come in more than one format. Smaller clients get the standard version; big customers like corporate retirement plans get an institutional version with identical holdings at a lower fee.

 

[tulak]

Right, it would need to be something like VTI and BND. No big deal, only a smidge more complex than the target fund.



-ERD50

Just for clarity, it’s not ETFs you need to move to, you need to move to ETFs or MFs that track an index, instead of a fund of funds such as the target funds.

VTI and VTSAX have similar distributions.

I agree that Vanguard dropped the ball on this one. They created this situation and should have realized how this would affect their customers beforehand.

In my case, DD has only a small amount in the 2060 fund, but I’ve always promoted the idea of buying a single fund and calling it good. It looks like I need to rethink that advice. This does simplify her move to Fidelity though, so that’s nice.

 

[ERD50]

Just for clarity, it’s not ETFs you need to move to, you need to move to ETFs or MFs that track an index, instead of a fund of funds such as the target funds.

VTI and VTSAX have similar distributions.

I agree that Vanguard dropped the ball on this one. They created this situation and should have realized how this would affect their customers beforehand.

In my case, DD has only a small amount in the 2060 fund, but I’ve always promoted the idea of buying a single fund and calling it good. It looks like I need to rethink that advice. This does simplify her move to Fidelity though, so that’s nice.

At least per yahoo finance, VTI has never (since 2000?) had a cap gains distribution, and VTSAX only a small one in 2000 and 2003. Are you thinking of dividends? Everything but BRK is going to kick of some of those.

Or maybe by "similar distributions", you meant they both have similar small distributions, not "similar to the target fund"?

-ERD50

 

[RunningBum]

https://www.mymoneyblog.com/vanguard-target-retirement-funds-nav-drop-cap-gains-distribution.html has the best explanation of why this happened that I've found. There was a large outflow of investments from VFORX ($10B out of $35B net assets) due to a change to a smaller minimum investment in the institutional version of the fund, so VFORX had to sell a lot of its holdings (at a big gain) to fund the redemptions.

From reading the annual reports for VFORX, we find that as of 3/31/21, the net assets for Target Retirement 2040 was about $35 billion. From January through September 2021, over $16 billion of shares were redeemed from the Target Retirement 2040 fund, while only $6 billion were purchased. The underlying investments grew in value, but investors took out a net $10 billion in cash over the first 9 months of 2021! The large capital gains distribution was primarily due to these large net redemptions.

Okay, but again, why? The main problem was that the “Institutional Target Retirement Funds” are not a share class of the “Target Retirement Funds”. In December 2020, Vanguard lowered the plan-level minimum investment requirement for the Institutional Target Retirement Funds to $5 million from $100 million. Now, as long as an employer’s 401k plan had $5 million in assets across the entire plan (not just one person), they could now access the much cheaper Institutional version… a big savings for possibly thousands of small businesses.

Let’s check the annual reports again. Over the same time period that Target Retirement 2040 lost $10 billion in net cash outflows, the Institutional Target Retirement 2040 Fund gained $13 billion in net cash inflows.

So Vanguard could have avoided this by bringing that Institutional fund minimum down more slowly, over a number of years. VFORX might have been able to pay off those leaving the fund with new investments and smaller cap gains sales each year.

 

[ERD50]

....


So Vanguard could have avoided this by bringing that Institutional fund minimum down more slowly, over a number of years. VFORX might have been able to pay off those leaving the fund with new investments and smaller cap gains sales each year.

Right. This was totally avoidable. As I said to DW, this is what they do for a living. This is their reason for existence. They should have anticipated this.

-ERD50

 

[tulak]

I was including all distributions, dividends and short/long-term gains, when I said similar distributions.

This may be a mistake on my part. I assumed that if VTSAX has a short/long term capital distribution, then VTI would have the same distribution. It looks like that might not be the case, but I’m not sure. Vanguard may have tools to prevent capital gains on VTI that it can’t avoid with VTSAX. I would have to investigate more to know for sure.

But as you noted, it’s been a long time since VTSAX had any capital gains distributed.

As a side note, one reason I’ve preferred funds vs ETFs is because I can invest dollar amounts. Fidelity now allows you to buy fractional shares, which removes a major hurdle for me in buying ETFs. I haven’t tried to place a fractional share order yet, but if it works as it should, this might move me to start buying ETFs instead of funds.

 

[ERD50]

I was including all distributions, dividends and short/long-term gains, when I said similar distributions.

This may be a mistake on my part. I assumed that if VTSAX has a short/long term capital distribution, then VTI would have the same distribution. It looks like that might not be the case, but I’m not sure. Vanguard may have tools to prevent capital gains on VTI that it can’t avoid with VTSAX. I would have to investigate more to know for sure. ....

As I understand it, ETFs are just structured differently, such that they don't end up with gains to distribute, the gains are all in the NAV, so you only realize them when you sell them (as it should be).

...

As a side note, one reason I’ve preferred funds vs ETFs is because I can invest dollar amounts. Fidelity now allows you to buy fractional shares, which removes a major hurdle for me in buying ETFs. I haven’t tried to place a fractional share order yet, but if it works as it should, this might move me to start buying ETFs instead of funds.

But you can buy non-round lots, and single shares (I wasn't aware you can buy fractional shares of an ETF, never tried) , but even so, a purchase rounded down a $200 or so isn't such a big deal, though I guess it is if you make weekly or monthly purchases. But you could use the excess the next period.

I also like that you can buy sell an ETF in real time, instead of an unknown closing price. Not a big deal in the long run, but I just like to place the orders, see them fill, document it, and I'm done, rather than waiting the next day and piecing that together. Just another little thing.

-ERD50

 

[GTFan]

The Wall Street Journal's Jason Zweig also has a thorough explanation of what happened in his Jan 21 Intelligent Investor column, which can be read here:


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

Paywalled, don't just post links summarize what happened.

 

[GTFan]

Just for clarity, it’s not ETFs you need to move to, you need to move to ETFs or MFs that track an index, instead of a fund of funds such as the target funds.

VTI and VTSAX have similar distributions.

I agree that Vanguard dropped the ball on this one. They created this situation and should have realized how this would affect their customers beforehand.

In my case, DD has only a small amount in the 2060 fund, but I’ve always promoted the idea of buying a single fund and calling it good. It looks like I need to rethink that advice. This does simplify her move to Fidelity though, so that’s nice.

It's always nice to say 'just move funds' when you don't have to incur huge CGs to do so. But the folks getting hit by this are the same folks that would, given returns in the past decade. It could take years to migrate over.

 

[aleabo]

I got hit as well. I'm a big fan of balance funds and especially TR as don't need to think of rebalancing and when time come to sell it easier to deal with one fund then several.
I have 2025 in my taxable for many years (more than 10) and never been hit before with large capital gains. But, taxes unavoidable ... Capital gains decreased cost basis, so when you sell taxes will be less..

 

[FANOFJESUS]

This is an unusual event I would not move funds over it.

 

[JoeWras]

It may be unusual but it shows disregard for the small investors. Who's to say they don't do this with another family?

I got into VBIAX (Balanced Index) over 2 decades ago. I have a lot of gains I can't scrub away. This fund is not convertible to ETF. If something happened to VBIAX like happened to the target date funds - say a 13% CG distribution - it would royally screw up my taxes.

Yeah, it is "just a gain," but when you are working on Roth conversions, it can throw you out of the CG relief zone.

VBIAX always gives off gains of a percent or 3. That's fine. It has pretty much always done this. A sudden change would be unfriendly.

BTW, VBIAX has an institutional twin (VBAIX) with a 5M minimum, so I don't think there will be the same problem. But who knows?

Once again, it pays to wait until December to do any kind of Roth conversions after you analyze the "estimated" gains published by VG. This TGF problem has been talked about since late last Nov. I feel really bad for investors who may have gone all in on a TDF in December, not knowing that they were suddenly about to take a hit. You can be sure there are plenty of folks out there in that boat.

 

[Masquernom]

Yep, I got caught also. I start withdrawals this year. Guess I'll start emptying the balanced funds first.