Bloomberg
Wealthy Americans fleeing tax hikes can shift turbochargers to ETFs
(Bloomberg) – The booming ETF industry may attract even more money in the years to come as wealthy Americans faced with higher capital gains taxes try to limit their debt for Uncle Sam. President Joe Biden’s plan to double the rate of those earning more than $ 1 million annually on investment gains would accelerate a shift where hundreds of billions of dollars are already migrating from mutual funds to exchange-traded funds, market watchers say. This is because ETFs are generally more tax efficient and have fewer capital gain payouts that could soon become much more expensive for some. In one respect, the tax efficiency of ETFs has been the main driver behind the tectonic shift in asset allocation in recent years. While the government’s plan is still in its infancy and needs to be scrutinized by lawmakers in the coming months, even a gradual increase in the capital recovery rate would likely lead to continued use of ETFs, according to David Perlman, ETF strategist at UBS Global “When tax rates on capital gains go higher, if you choose a structure that helps defer capital gains and gives you more control over when to recognize those gains, you are more inclined to move in that direction,” said Perlman. When an investor leaves a mutual fund, the fund manager must sell securities to raise cash for redemption. The same investor who leaves an ETF can resell their shares to another investor, which means that neither the fund nor its manager have made a taxable transaction, instead of the ETF issuer exchanging the underlying securities of the fund with a market maker to act in cash. This means that the ETF rarely makes a taxable sale. A December study by researchers from Villanova and Lehigh Universities found that over the past five years, on average, ETFs have levied a tax burden 0.92% lower than active mutual funds. For wealthy investors in particular, tax considerations have outweighed both performance and fees as the main drivers behind the inflows from active mutual funds into ETFs. The results showed, “There’s no question that Biden’s plan to raise capital gains tax could be a boon to ETFs,” said Nate Geraci, president of the ETF Store, a consultancy, via email. “Despite significant gains in market share by ETFs over the past decade, trillions of dollars are still tied up in less tax-efficient mutual funds.” In the past year alone, the ETF industry raised nearly $ 500 billion, while mutual funds lost around $ 362 billion, according to data compiled by Bloomberg.ETF. Most ETFs these days hardly ever pass capital gains on to shareholders. Only 3 out of 585 in a CFRA analysis made withdrawals in 2020, Todd Rosenbluth, director of ETF and mutual fund research, wrote in an April 26 report. During the same period, 37 of 39 T. Rowe Price Group Inc. domestic equity funds made a capital gain. The analysis found, “We expect that more people who mix ETFs and mutual funds will be more likely to turn to strategies Avoid paying higher capital gains taxes in the future,” wrote Rosenbluth. Even investors unaffected by the higher interest rate could migrate to ETFs, he added. The discussion of capital gains alone reminds investors of the industry’s innate tax advantages over mutual funds. Others are not convinced that a higher capital return rate will do much to boost inflows into ETFs. Wealthy investors would have to sell their mutual fund holdings to make the switch, which creates significant tax liabilities, said Michael Zigmont, director of trading and research at Harvest Volatility Management. “I don’t see this tax hike as good or bad for ETFs. In the meantime, ETFs don’t suit every investment need. For example, the US pension system remains heavily funded. Still, Perlman agrees with Rosenbluth that the potential tax change could even affect investors below the $ 1 million annual breakeven bracketing line or worried that the threshold may be lowered later will likely postpone their future allocations as well, said he: “The incentives are broader than just those affected by the proposal,” said Perlman. For more articles like this, visit us at bloomberg.com. Sign up now to stay up to date with the most trusted business news source. © 2021 Bloomberg LP
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