SEC Requires Disclosure of Mutual Fund After-Tax Returns
FOR IMMEDIATE RELEASE
Washington, D.C., January 19, 2001 The Securities and Exchange Commission announced today that it had adopted rules requiring mutual funds to disclose standardized after-tax returns. The rules are designed to help investors understand the magnitude of tax costs and compare the impact of taxes on the performance of different funds. The text of the rules is available on the Commission's website at http://www.sec.gov/rules/finrindx.htm.
In April 2000, the U.S. House of Representatives passed, by a vote of 358-2, the "Mutual Fund Tax Awareness Act of 2000," a bill introduced by Congressman Paul Gillmor that would enhance the information that mutual fund shareholders receive about after-tax returns. Today's Commission action, which shares the goals of Congressman Gillmor's legislation, will provide investors with this improved information.
Taxes are one of the most significant costs of investing in mutual funds. Recent estimates suggest that more than two and one-half percentage points of the average stock fund's total return is lost each year to taxes - significantly greater than the amount typically lost to fees. Despite the dollars at stake, many investors lack a clear understanding of the impact of taxes on their mutual fund investments, particularly the fact that differences in fund investment strategies can produce markedly different tax consequences.
Paul Roye, Director of the Commission's Division of Investment Management, said, "Taxes can be the most significant cost of investing in a mutual fund. Today's action addresses the gap between the importance of taxes to mutual fund investors and the knowledge that investors have about taxes."
The following provides background information and more details on the Commission's action.
- In 1999, mutual funds distributed approximately $238 billion in capital gains and $159 billion in taxable dividends. Recent estimates suggest that more than two and one-half percentage points of the average stock fund's total return is lost each year to taxes.
- The 'tax-bite' varies widely from fund to fund. One recent study reported that the annual impact of taxes on the performance of stock funds varied from zero, for the most tax-efficient funds, to 5.6 percentage points, for the least tax-efficient. The size of the tax-bite depends on several factors, including the level of portfolio trading and the amount of gains realized on trades, as well as the degree to which the manager uses portfolio losses to offset realized gains.
Many investors lack a clear understanding of the impact of taxes on their mutual fund investments. In one recent survey, 85% of fund investors stated that taxes play an important role in investment decisions, but only 33% felt that they were very knowledgeable about the tax implications of investing, and only 18% were able to identify the maximum rate for long-term capital gains.
- Last year, the U.S. House of Representatives passed, by a vote of 358-2, the "Mutual Fund Tax Awareness Act of 2000," a bill introduced by Congressman Paul Gillmor that would require improved disclosure of mutual fund after-tax returns.
The rules require a fund to include after-tax returns for 1-, 5-, and 10-year periods in its prospectus.
Types of Returns. After-tax returns will be presented in two ways, after taxes on fund distributions, and after taxes on fund distributions and sale of fund shares:
- Return after taxes on distributions includes the effect of taxable distributions by a fund to its shareholders but not any taxable gain or loss that would be realized by a shareholder on the sale of fund shares, thereby reflecting the tax effects on shareholders of the portfolio manager's purchases and sales of portfolio securities.
- Return after taxes on distributions and sale of fund shares includes the effect of both taxable distributions by a fund to its shareholders and any taxable gain or loss realized by a shareholder on the sale of fund shares, thereby reflecting the tax effects on shareholders of both the portfolio manager's purchases and sales of portfolio securities and a shareholder's individual decision to sell fund shares.
Format of Disclosure
Before- and after-tax returns will be presented in a standardized table to help investors compare the returns of different funds. The table will be accompanied by a short explanation of the returns presented.
Formulas for Computing After-Tax Returns
After-tax returns will be computed using the following assumptions:
- Taxes are imposed at the maximum individual federal income tax rate. Computing after-tax returns with maximum tax rates will provide investors with the "worst-case" federal income tax scenario. When coupled with before-tax returns that reflect the imposition of taxes at a 0% rate, this "worst-case" scenario will effectively provide investors with the full range of historical after-tax returns.
- Distributions are taxed at historical tax rates in effect when the distributions were made rather than rates in effect when the calculation is performed. The use of historical tax rates will more accurately reflect a fund's actual after-tax returns than would the use of rates in effect at the time after-tax returns are computed.
Exemptions from After-Tax Return Disclosure
After-tax returns are not required for:
- Money market funds because the tax consequences of investing in different money market funds should be similar since their returns are generally in the form of income distributions, which are taxable on a current basis.
- Funds using prospectuses exclusively for investors in tax-deferred arrangements such as 401(k) plans or variable annuities, or for entities not subject to the individual federal income tax, because these investors either are not subject to current taxation on fund distributions or are not subject to current taxation at the individual federal income tax rates, and their tax consequences on a sale of fund shares are different from those experienced by individual investors in taxable accounts.
Funds are required to include standardized after-tax returns in any advertisement that:
- Includes any after-tax performance information; or
- Includes any other performance information together with claims that the fund is managed to limit or control the effect of taxes.
For further information, contact Susan Nash at (202) 942-0630 or Kimberly Dopkin Rasevic at (202) 942-0721.
Additional Materials Available on This Topic
Final Rule: Disclosure of Mutual Fund After-Tax Returns