Following up on my previous post, Wall Street Journal: The Huge Tax Bills That Came Out Of Nowhere At Vanguard: New York Times, For Taxes, Where You Hold Your Investments Really Matters:
Tax bills are bad enough when you know they are coming. When they are unexpected and large, and come from what seemed like a safe and reliable place, they are infuriating.
That’s a rough summary of the effect of the big bills that some investors face because they hold retirement funds run by Vanguard and a handful of other fund companies in taxable accounts.
This tax problem hasn’t arisen for people who hold these so-called target date funds in tax-sheltered accounts — workplace retirement accounts like 401(k)s, or I.R.A.s. But for investors holding target date funds in ordinary, taxable accounts, it’s a different story. …
[A] series of seemingly routine actions taken by Vanguard that lowered costs for the majority of shareholders who own these funds in retirement accounts resulted in unexpected bills for everyone else. …
What Vanguard did seemed innocuous at first.
In December 2020, it reduced the minimum needed to invest in the “institutional” target date funds used by many companies for employee retirement accounts. The threshold dropped to $5 million from $100 million. For people using the institutional funds through their workplaces, the fees were only 0.09 percent. For individuals using the retail funds, the fees were 0.14 percent.
Cheaper is better for investors, so that announcement set off a flood of sales of the retail funds, effectively requiring the fund managers to liquidate underlying investments. That, in turn, set off capital gains distributions for the diminished pool of retail investors who remained at the end of the year, Morningstar has found. Vanguard’s long-term capital gain distributions in 2021 averaged 12.1 percent, compared with less than 1 percent in recent years.
How Vanguard handled its target date funds is the subject of a class-action lawsuit filed this month in Pennsylvania by three plaintiffs. “These massive distributions resulted from Vanguard’s own decision to favor its larger retirement plans over its smaller, taxable investors,” said Jonas Jacobson, one of the lawyers who filed the suit.
The suit says the sequence of Vanguard’s actions is important.
A year after Vanguard set off the mass sales of its retail funds by lowering the institutional threshold, it merged the institutional and retail versions of the funds and lowered fees for all investors to 0.08 percent. (They are cheaper for corporate plans that hold the funds as trusts; at The Times, the fee is 0.065 percent.) But Vanguard could have first merged the funds, then lowered the fees, the suit says. If the process had proceeded in that order, the lawyers argued, there would have been no flood of fund sales and no tax shock for retail investors.
