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Tax Efficient Funds Will Shine Under New SEC Rule

Showing after-tax returns will make tax-friendly funds look good.

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New federal rules requiring funds to show investors how big a bite the taxman takes out of their returns could encourage more investors to consider funds that seek to minimize their shareholders vulnerability to taxes, particularly the growing legion of tax-managed funds.

This spring all mutual funds will have to start disclosing after-tax returns in their prospectuses and annual reports. The Securities and Exchange Commission has approved a rule requiring funds to reveal after-tax returns for one-, five-, and 10-year periods in their prospectuses. Starting in April, funds will adjust returns using the top federal income-tax rate, 39.6%, and display them in two ways. One assumes investors hold their shares for the whole measuring period and pay taxes only on capital-gains and dividend distributions (so-called pre-liquidation returns). The other assumes shareholders sell their piece of the fund at the end of the period and pay capital-gains taxes (post-liquidation returns).

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Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.