1. Mutual Funds
2. Additional Information
3. 401K and Retirement Accounts

Generally, capital distribution is defined as the payment of money or other property to owners, based on their ownership.

Mutual Funds

If you own any mutual funds, you may already have a certain level of familiarity with the idea of capital distribution, as this may be something that you are required to include on your annual tax returns, also known as a return of capital distribution. This is sometimes called a mutual fund distribution, and must be paid out at least once a year.

So, what is a return of capital distribution? This may also be called a non-dividend distribution. A return of capital distribution occurs when the mutual fund pays out a portion of the original investment made by the owner of the fund. This may sound complicated, but think if you buy a mutual fund for $100, but it grows to be worth $150. You may receive a capital distribution of $50, generating income off your original investment.

With that said, unless your capital distributions are a part of your regular income (for example, if you are a retiree), most people choose to reinvest the capital gains back into the fund, until such time as they may be needed as income.

This may raise a lot of questions or concerns regarding taxes, but the good news is that the capital distribution is not taxable. However, you will still need to ensure that your income is being fully reported upon, and that your tax returns are being completed, correctly, If you are receiving capital or non-dividend distributions, you will need to complete a Form 1099-DIV. This form is easily found on the website for Internal Revenue Service or can be obtained (and, completed) by an accountant or financial advisor.

Additional Information

There are often many questions that an investor may have regarding the tax implications of their investments, how to reinvest capital gains, when to use capital gains as a source of income, and the like. Some of these questions and answers also include:

  • How often do capital distributions occur? Generally speaking, the distributions will take place either quarterly or annually. If you are using your capital distributions as a regular source of income, this is an important fact to keep in mind, as you develop your household budget.
  • Why do mutual funds pay dividends and distributions? Simply put, they are legally required to do so. However, the owner of the mutual fund has the choice as to whether or not they receive the distribution or reinvest it back into the fund.
  • How does a mutual fund actually generate income, or capital distributions? Generally, by one of two ways: either by selling investments whose value has increased (buy low, sell high, right?) or by interest earned on the existing investments.
  • Are there different types of capital gains distributions that can be made from a mutual fund? Yes, there are! There are short term and long term gains. A short term gain is the money generated from the sale of an investment that was only owned for one year or less. Obviously, then, a long term gain occurs if the investment had been owned for over year, prior to its sale. Either of these will be required to be reported to the IRS at the end of the year on the IRS Form 1099 DIV.
  • If I choose not to receive a cash payout on my capital distribution, but choose, instead to reinvest it back into the fund, am I required to report that to the IRS? Yes, you will need to complete the IRS Form 1099 DIV.

401K and Retirement Accounts

Mutual funds are not meant to be confused with a 401(k) or other types of accounts that are designated as retirement accounts, such as IRAs (also known as Individual Retirement Accounts). 

With a 401(k), the accounts are tax-advantaged. This means that the owner of the account pays taxes on the return only if and when money is withdrawn. (Generally, beginning at retirement. However, money can be collected from an IRA or 401(k) prior to retirement, if need be, although the fund owner will be forced to pay penalty fees for doing so.)

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