By Dr. Jim Dahle, WCI FounderAt the end of 2021, the Vanguard Target Retirement Funds made massive Long Term Capital Gains (LTCG) distributions. This caught a lot of people by surprise. Index funds, like those that make up the Target Retirement Funds at Vanguard, don't generally distribute much in the way of LTCGs. They don't have very high turnover, and most of them have an Exchange Traded Fund (ETF) share class that allows the fund to flush capital gains out without sending them to investors. However, a combination of factors and one seemingly minor event combined to really sock it to investors who valued simplicity over tax efficiency.
Vanguard Target Retirement Funds Are Fine . . . in Tax-Protected Accounts
Target Retirement (TR) Funds are funds of funds that provide a one-stop investing solution. You pick a date near when you want to retire and put all of your money into the fund closest to that date. You forget about it, and the fund manager keeps the various asset classes in balance and, over the years, slowly decreases the aggressiveness of the mix. Easy-peasy.
However, I (and just about everyone else) have long warned that Target Retirement and other “lifecycle” funds were not the most tax-efficient way to invest. If you have both retirement accounts and taxable accounts, this may not be the best option for you. It keeps you from eking out a little extra return using savvy asset location techniques. Whether bonds in taxable or stocks in taxable are right for you, one of them is going to be in the wrong “place” when you use a fund of funds.
But if you're really into simplicity (like Mike Piper at the Oblivious Investor who uses a single Vanguard Life Strategy Fund in all of his accounts), you may be willing to trade a little tax efficiency for the hassle and behavioral benefits of a fund of funds.
However, even I never expected what happened in 2021. Neither did Piper when I asked whether this had given him pause at all about his strategy.
“Admittedly, I didn't see something like this coming,” he said. “But it's just another bullet point under what I (and plenty of other people) have been saying for years: they're not a good fit for taxable accounts.”
Note that while Mike uses a single fund of funds in all of his accounts, he does not have a taxable investing account.
The Vanguard Target Retirement Fund Disaster
As Jason Zweig explained in the Wall Street Journal:
“At the end of 2020, Vanguard reduced the minimum investment in its institutional Target Retirement funds to $5 million from $100 million. That set off an elephant stampede, as multimillion-dollar corporate retirement plans got out of the standard target funds and into the institutional equivalents. (Clients have to sell out of one format to buy the other.)
Last year, assets at Vanguard’s 2035 target fund shrank to $38 billion from $46 billion at year-end 2020; the 2040 fund shriveled to $29 billion from $36 billion. As big clients left, their sales caused the funds to offload some holdings, triggering capital gains—which could be distributed only to the dwindling group of investors who stuck around. Some had made the mistake of owning these funds in taxable accounts.”
Remember, a typical LTCG distribution for the underlying funds in Target Retirements funds such as Total Stock Market Index Fund, Total International Stock Market Index Fund, and Total Bond Market Index Fund is 0%. But for 2021, the distributions were as follows:
As you can see, most of these funds had double-digit capital gains distributions. It was 18% for TR 2040! That fund only made 14.56% in 2021. But investors owning it in taxable now have to pay taxes on 18%, and that doesn't even include dividends and short-term capital gains. The total distribution yield for 2021 was 24%. (It was as high as 27% for the 2015 fund.)
Now, this was no big deal for those who were investing in a Target Retirement fund in their Roth IRA or their 403(b) at work. But for those who were invested in the fund in a taxable account, the results were shocking and costly.
Zweig talks about a redditor called Sitting Hawk:
“[Sitting Hawk] received about $550,000 in distributions in Vanguard’s Target Retirement 2035 fund. So he owes 23.8% in federal tax and 4.95% in Illinois state tax—all told, more than $150,000 . . . He put about $1.9 million into the fund in a taxable account in 2015 after he maxed out contributions to his tax-deferred funds. He added more savings; by last year, he had about $3.6 million in taxable money in the fund.
‘I didn’t want to be that guy who’s constantly trading,' he says. ‘I just wanted to set it and forget it and have some peace of mind instead of messing around with it every couple of days. It sucks that this had to happen. HOW COULD VANGUARD LET THIS HAPPEN?'”
Now that is an extreme situation (and obviously a first-world problem, like most we discuss here on this site). But it does demonstrate just how bad this could be. Imagine getting an extra half-million in taxable income you weren't expecting and didn't need?
Lessons to Learn from Vanguard Capital Gains Distributions in 2021
There are some lessons we can take away from this. Let's go through them one by one.
#1 Funds of Funds Are for Retirement Accounts
The first one I will repeat for those in the back. If you have a taxable investing account, a fund of funds like the Vanguard Target Retirement or Life Strategy funds is not a good choice for you. I'm sorry. This is one of the problems of being wealthy. Mo' money, mo' problems, remember? You'll have to manage (or pay someone else to manage) a more complicated portfolio—or suffer the tax consequences.
Those who held a TR fund in a Roth IRA? No big deal. Vanguard just reinvested the LTCG distributions like the dividend distributions. No tax due. No downside at all.
#2 You Can Get Massive Capital Gains Distributions Without Having Any Capital Gains
Imagine if you had bought TR 2040 in your taxable account in November 2021. You didn't really have much of a return that year, but you still got walloped with the same 18% LTCG distribution. This is the case with many mutual funds. When you buy into a mutual fund, it often already has some embedded capital gains. If a large investor leaves the fund and forces the fund to sell shares of those low-basis securities, you'll be left holding the LTCG bag.
#3 Funds Without ETF Share Classes Are Vulnerable
One wonderful thing about the Vanguard index funds is that they have an Exchange Traded Fund (ETF) share class. When a large investor wants out, they simply pass them the individual securities instead of selling them and giving them cash. So, the remaining investors aren't hurt. Meanwhile, the fund is continually flushing appreciated shares out of the fund, raising the basis, and reducing future tax bills. The ETF unit creation/destruction process improves tax efficiency. In fact, the Vanguard Total Stock Market Fund has not distributed a capital gain in decades. Decades. Zero percent and certainly not 18% in a single year.
The Target Retirement Funds, like most mutual funds, do not have an ETF share class. While it does not matter so much whether you own the Vanguard fund or the Vanguard ETF in taxable for those funds that have both share classes, it certainly does for other mutual funds (Vanguard and non-Vanguard) that do not have both share classes. In those cases, use ETFs preferentially in taxable.
#4 Fund Companies, Even Vanguard, Aren't Always on Your Side
Whether anyone at Vanguard thought about this in advance is not clear, but the company certainly had competing priorities to weigh. It wanted to serve its institutional investors, and it wanted to serve its individual investors. Vanguard wanted to take care of those who invest inside retirement accounts and pensions and those who invest outside of retirement accounts. In this case, Vanguard decided it didn't care about those individual investors who were holding Target Retirement funds in their taxable accounts as much as they did the big institutional investors.
Fund companies, even Vanguard, make decisions like this all the time. Be aware. This problem is simply a consequence of how mutual funds have been taxed ever since the Investment Company Act of 1940. The funds must pass through their capital gains, whether the investors saw gains or not. It's not really fair and I don't think it is good tax policy, but this is how it works. And for some people at the end of 2021, it was awfully costly.
What do you think? Have you ever been hit with a capital gain you weren't expecting? Do you own Target Retirement funds? In taxable? What are you doing to reduce this risk in your life? Comment below!
so if i have 200k in a target retirement fund in a brokerage account… what do i do now? do i leave it and just invest differently in the future or transfer the money to other funds? don’t i lose (more) money if i sell now?
You’ve found the dilemma that people who own this are now facing. The market is down 10% right now, maybe not a bad time to get out if you don’t want it long term.
If I move money from a target date fund to other funds but still with Vanguard is that considered selling?
Yes.
Because of the recently completed merger of each institutional TR fund into its “regular” TR counterpart, this issue should not occur again in the TR funds. TR funds always generate CG but last year was an aberration due to Vanguard’s very foolish decision. I still have heard nothing about any class action lawsuit about this matter yet
These target date funds normally have a small amount of turnover and a few gains and dividends. While not ideal for taxable accounts they are still quite acceptable in most cases.
Problem here is Vanguard sabotaged the fund to get better deals for mid-sized institutions. They were fine as they were tax deferred when they switched 401k plans into the Institutional Class funds. Smaller holders with taxable accounts got toasted. No explanation from Vanguard nor did they address the question of Fiduciary duty to the taxable shareholders.
And they are doing it again. They are now reducing the minimum of yet another class of funds from $250M to $100M in 2022. Expect more outflows this year, requiring more fund liquidations and capital gains allocated to the remaining shareholders, including again those in taxable funds.
Which funds?
All the Target Date Funds. Vanguard treats these all together. In my case it was Vanguard TDF 2020 but the story is similar for all of them
Jeff
Wow! After reading the entire thread, I had the impression that Vanguard would not repeat the capital gains disastrous surprise in 2022. However, your comment indicates it will happen again. Could you be more specific why this will occur before I escape from my taxable target 2020 fund?
Am doing this from memory……
In September 2021 Vanguard announced they are merging the Institutional and Investor Classes of the TDFs and reducing the fees to 0.08%. In that announcement they also announced that they would be reducing the minimum for the Vanguard Target Retirement Trust II from $250M to $100M. There are no fees in that trust and Last year Vanguard took care of investors with assets between $5M and $100M. This year they will be taking care of those with assets between $100M – $250M. Would expect another exodus from the normal funds as a different group of larger investors now has a chance to get a better deal.
I believe it is a matter of the minimum investment to get in, not the total amount of funds to be invested.
Jeff
I found the September 2021 Vanguard announcement regarding the issue you mentioned. The announcement stated that “Effective immediately, Vanguard Target Retirement Trust II will have a new lower $100 million minimum, allowing plan sponsors and their employees to access even lower-cost target-date options.” Therefore, I believe that the reduction of the minimum investment for the the Vanguard Target Retirement Trust II (which could potentially result in another investor stampede from the regular target funds) already occurred and that the capital gains distribution surprise of December 2021 included such event. Do you believe this will decrease (but not guarantee) the chance of another Vanguard capital gains distribution surprise in 2022?
Hi Albert, good catch on “immediately “. Don’t know about any late year outflows as the last data from VG was dated 9/30
Definition of malice: “intent to do evil”. Vanguard was plain stupid and did not think through the consequences of the impact of LTCG on taxable accounts. The unfortunate reality is that a “run on the bank” can happen to any mutual fund from any company. Vanguard was helping their institutional clients by reducing fees but completely botched the execution. Was it illegal? I think not but we’ll find out.
I have owned individual securities over the years that had huge appreciation. Some of the stocks got liquidated due to mergers and acquisitions. As a result I was subject to sizeable LTCG. It played havoc with my tax and retirement planning since I was not expecting any realized gains that would funnel me into higher tax brackets. Just had to grin and bear it.
Hey guys, question doesn’t Vanguard mutual funds use ETF’s as a share class, and theoretically should not have had huge cap gains to cause this debacle? So if Vangaurd’s TDF’s use underlying Vanguard mutual funds, the Vanguard mutual funds can just exchange/destroy the ETF share class, right? How did that mechanism of Vanguard’s break down?
There is no ETF share class for the Target Retirement Funds. This wasn’t an issue of the underlying funds, but of the target retirement funds themselves.
My experience with VWALX, a municipal bond fund, reached a new low in 2021. My 1099 DIV 2021 Form show entries for ordinary dividends (called short-term capital gains by Vanguard, I had none), 0.00 for qualified dividends, entry for total capital gains (not mine), exempt-interest dividends(mine), and specified private activity bond interest dividends(for AMT calculations, expected).
First number goes on Schedule B, line 5, third number on Schedule D, line 13.
I have had long-term capital gains surprises several times, but this is the first time I have had to pay short-term capital gains not generated by me. It does no good to tell me to not put this fund in a taxable account. I retired in 1991 and have not had earned income ever since.
It seems Vanguard is not now following their fiduciary requirements of performing as well as comparable index funds. (See Rick Ferri Boglehead interview #41 with Watkins.
Why are you in a muni bond fund? Is that really providing a better after-tax return for you than a fully taxable bond fund?
I can’t figure out why you’re complaining about a tiny capital gains distribution for 2021. You know that fund had one in 2020 and 2019, right? The 2021 distribution was tiny. 2.3 cents per $12 share. If it really bothers you, you could buy individual bonds and run your own fund. But this is dramatically different from the situation this post is talking about. This certainly isn’t evidence of Vanguard shirking their fiduciary duty. This is just what mutual funds do.
I have been using VWALX for many many years and only in the last three have they provided any evidence they are active managing the fund, that is, reporting long term or short capital gains, effective the last days of December. My understanding of municipal bond funds like VWALX is they have a turn over rate of about 17%, not caused by active management but just the consequences of how bond funds work. It appears Vanguard has now moved to active management of municipal bond funds n the last three years. For me, the rubicon was the appearance of short term capital gains. I don’t ever pay long term capital gains tax, unless . . somebody adds too much in an end of addition.
Fact: about 85% of active managed funds do not match or beat their index fund companion. The 15% that do, are not the same year by year so it appears to be a random event, not a measure of talent.
Fact: Fiduciary requirements expect matching or beating corresponding index fund. There is a current case at the Supreme Court that may very likely confirm that standard.
I have always believed Vanguard believes in that standard until the latest changes in their behavior. TIAA-CREF does not meet that standard. As you often agree, most company investment programs do not do that either, but their matching program may justify using them anyway, until you retire. Then get out fast.
I’m sorry you say all mutual funds do this stuff. Get used to it. Listen to the Watkins interview with Rick Ferri and I think you will change your mind about the role of Fiduciary standards and how mutual funds behave.
It surprises me Vanguard is encouraging more active management of their non-index funds when they know it doesn’t work. I believe in their philosophy of making me an “owner” of Vanguard. Your targeted funds problem is the same issue. Fiduciary requirements should fix it.
If an active fund had liability for underperforming an index fund, there would be no active funds.
Vanguard has ALWAYS believed in low cost active management. That’s not a new thing. For a long time Vanguard had most of its funds in actively managed funds.
Thank you for this article. Until I read it, I thought some kind of error occurred when my CPA sent me an email two days ago giving me a “heads-up” that I was going get socked for $34,000 in capital gains taxes (roughly equal to my entire first year of Social Security that I began taking when I retired last year). “Chris” would call me lazy or stupid, and perhaps I am both when it comes to investing. On the other hand, my CPA, while not a financial advisor, had no idea what happened either until I found your article and the WSJ article. And it’s because I’m not particularly knowledgeable about investing that I rely on Vanguard and simple index funds. I am stunned and disappointed they would let this happen. As collateral damage, I saved approximately $400 a month in Medicare Part B IRMMA adjustment payments in 2021 because I estimated my 2021 income (which no longer included my wages) based on last year’s capital gains distributions/taxes. Does anyone happen to know if the SSA will try to claw that back?
I think IRMMA is based on income from two years back. So in another year or so, you’re likely going to pay a bunch more because Vanguard hosed you by this move.
Generally, that is true. The SSA will use your most recent available tax return to determine your IRMAA amount. However, if you’ve experienced a life-changing event such as “work stoppage” due to retirement, SSA-44 Form (Medicare Income-Related Monthly Adjustment Amount – Life-Changing Event) allows you to estimate your new annual income, assuming it is approved by SSA. I was able to successfully do this for 2021, but my estimate did not take into account the unexpected wallop of $132,000 capital gains taxes on my Vanguard Target 2020 and 2025 funds.
Yes they will.
Agree with all comments re being blindsided by Vanguard . Those indicating there was plenty of warnings must be professional investors.
But what to do now to avoiding a repeat? Is a like situation expected to occur in 2022? To get out means to sell all and have
An even bigger taxable cap gain.
Amen to your comment about Target folks being “owners” and getting this big hit. It does hurt. By comparison my hit with VWALX was very small, my taxes went up just 10%. Investigating, I was surprised to see all but one of the municipal bond funds are now 20% Schwab. There is quite a list of options the managers now have to play with.
What worries me is, is this a trend? For my fund, it’s the third year in a fund I’ve used for say, 20 years, with no December surprises and a serious, successful effort to come close to an index fund with municipal bonds, not an easy trick, but done very well until the last three years. Is the 20% Schwab now done as an advantage to me? Why?
Is it good to now have ordinary dividends? Short term capital gains? These are new. Why? It doesn’t feel good to this owner.
With VWALX I have been through many market crashes with very short recovery times compared to VTSAX alone. (I balance the two using their dramatically different standard deviations as my guide to needed proportions to give each an equal effect.). I have been a happy camper for many years.
Will everyone run to the only index municipal bond fund with an ETS option because they expect it to protect them from the recent results of my favorite muni and I’ll get the big LTCG hit in 2022? I believe in Bogle’s stay-the-course philosophy and Bill Bernstein’s you’ve-won, stop-playing-the-game advice so I’ll probably sit tight and complain. I have been retired for 30 years and still add to my portfolio every year.
Thanks for the good coverage and I hope the Fiduciary requirements and Vanguard slowing down and thinking a bit about what their founder might say will keep Vanguard on the straight and narrow. It would be a shame if abandoning Vanguard is the solution because they have just become another Schwab or Fidelity with stock holders that expect to be paid.
Well, at least this isn’t affecting the comfort of your retirement!
Jonas Jacobson and his firm filed a class action against Vanguard today. Just received a copy of the complaint.
It’ll be interesting to see where it goes. Unfortunately, it costs all of us money to defend it whether we are in the class or not!
That’s true, although I still very much hope the suit gets traction. Even though it’s been a month later finding out about this disaster, I am still livid with Vanguard. I feel betrayed for thinking (for the last 25+ years) that they were looking out for me, unlike other companies. Not only am I hosed this year, but I can’t roll over those Retirement 20XX funds without incurring the rest of the unrealized gain, so now I am just waiting for the next tax-bomb to go off when I least expect it.
I’m sorry this happened to you.
Have you never heard that holding a fund of funds in taxable is a bad idea from anyone? A book? A forum? A blog post? I mean, I guess one could expect Vanguard to tell you that, but it does kind of leak over into the realm of giving tax advice, which they cannot legally do. I just think the lawsuit probably isn’t going anywhere, but we’ll see.
I invested in that fund many years ago. After our company offered it as a 401k choice (which I also do), I looked into it and liked the idea and the historic pattern (including dividends/cap gains) seemed reasonable, so over a long period of time I converted other Vanguard funds I owned into that target retirement fund.
That being said, I do get that this situation is largely my fault (honestly I oscillate between being angry with myself and angry with Vanguard), if I was better informed earlier I wouldn’t have done it, and now I have to accept the punishment for my ignorance. But it’s not like I wasn’t paying attention to what was going on, just suddenly here it was, a giant cap gain at the very end of the year with no warning and no way to deal with it, so I feel at the very least Vanguard could have found some other way to mitigate the damage by their change.
Anyhow, sorry for the negativity, I really appreciate the insights on your blog and hopefully this will be a good learning experience for me in the end.
More on the lawsuit here:
https://www.investmentnews.com/suit-against-vanguard-focuses-big-tax-bills-target-date-funds-218591
I was hit with a capital gain of about 20% for investing about a week before the dividend date. That small investment will cost me since I will lose the EITC for going over $10,000 in capital gains. Vanguard should have disclosed this. And I have a loss on the fund on top of it all. I don’t think there is any up side to this. I invested in Vanguard because they put so much effort into avoiding tax pitfalls and I’ll be more careful in the future. Over $3,000 in taxes on a $10,000 investment.
That might be one of the worst stories I heard from this.
I got hit with $13K tax bill with my unexpected distribution. Thankfully, just this week, I sold my entire holdings and thanks to the decrease in stock/fund price that was a consequence of the LTCG distribution, I was able to sell at a loss
Hopefully your loss will offset the distributed gains.
Unfortunately, I can’t offset those gains from 2021 in 2022, but maybe future gains. What frustrated/aggravated me most about what Vanguard did was that they recorded/distributed the gains on the very LAST market day of 2021, after the market closed. Thus, there was no way to offset the gains with harvesting losses. That is why I think the lawsuit is legitimate. Had Vanguard made this change earlier in the year, we could have mitigated the situation by countering the gain with selling other holdings at a loss. Vanguard gave us no opportunity to react.
I think we’ll find out in court. Fortunately for me and unfortunately for you, I get to be an almost dispassionate observer (although I have to pay a tiny share of the defense costs) but you not only have to pay for both sides of the legal costs, but definitely care about the outcome.
My VFORX is in a Roth IRA so I believe since it’s set to reinvest I didn’t get this big tax hit everyone’s angry about. However, I feel like I got hit even worse; the value of my VFORX took a nosedive, from over $50 to around $35 or soemthing per share, i mean the value of this account just plummeted. This sounds like Vanguard marketed/advertised a different target retirement vehicle to businesses whose employees were using VFORX, so when the businesses transferred out of (sold) VFORX to go instead into those other Target Retirement accounts, it tanked VFORX. This seems like a horrendous way to manage anything. Should ppl in VFORX not have been told that Vanguard was steering significant portions of the holders out of VFORX into something else? This is like being deliberately sabotaged. VFORX had a massive straight-line drop from 50 to 38 or something, and now has hovered there for months. Would we expect it to EVER recover? If Vanguard is steering customers to other target retirement vehicles, won’t VFORX just keep going down? I feel like I got screwed by Vanguard on purpose. Should I just realize this massive loss and get out before Vanguard advertises yet another alternative to their own VFORX? How long before it gets back up to 50?
That doesn’t matter if you now own more shares. Same same in a tax-protected account. You were not hurt.
I have significant chunk of money in taxable target retirement at vanguard. Does it make sense to move it to vanguard total stock index fund? I read in one of the post above that vanguard has taken precautions so that it will not happen again. Is there any formula I can use to calculate how much tax I will be paying I switch to total stock index fund? Thanks
Sure, log in and click the tab for unrealized capital gains. That’ll tell you exactly how much. Just multiply that amount by your LTCG bracket.
Thanks for your help. I used to like target retirement fund as it automatically increases bond percentages with age. How will I do this adjustment with total stock index fund? Thanks
Hey Rahul you can just look up asset allocation the target date fund uses and buy the same percentages of total stock index funds and bond funds by yourself. you can just check maybe every year and rebalance that way.
You might want a muni bond fund too. But basically, you can just do what the TR fund was doing for you.
I thought exchanging between different funds in a brokerage account is a taxable event. Vanguard told me today that if I exchange my target retirement fund to total stock index fund will be taxable. Thanks again for helping me out.
Hey Rahul yes it is a taxable event if your TRF (target retirement fund) has a capital gain on it. Have you made money on it? If so I would not realize those capital gains by selling the TRF unless you have done some tax loss harvesting and have some losses that can offset those gains. from your post I would guess you haven’t tax loss harvested. If so I would “build around” your TRF and start buying a total stock market index fund in taxable as well as bonds in your tax advantaged accounts such as traditional 401k or traditional IRA. or you can get a muni bond fund as Jim suggested in taxable. You buy these funds in the same proportion as your TRF.
I’m sorry this unforseen cap gain happened to you, but hey, could be worse. a couple of my friends got placed actively managed funds that they have held for years which have very low basis and throw off cap gains much worse than this Vanguard event.
You may already be in luck depending upon which target year funds you sold and how long you had held them. My forced “gain” for 2021 was the equivalent of 5 years worth of increasing share price and after the gain was distributed, the price of the fund dropped back down to a 2017 level. I then sold all the shares (unfortunately, in 2022 rather than in 2021) and actually ended up with a loss!
You are right and so is Vanguard. If you want to change, it’ll cost you some taxes. So you may just want to change with new contributions and leave the older money where it is.
Which vanguard muni bond fund would you recommend? Is it vanguard intermediate municipal bond fund ? I hope future interest rates hike will not affect my bond fund choice. Thanks
That’s the one I use. Yes, future interest rates hikes will affect your bond funds, no matter which one you choose.
What do you think about total bond market index fund instead of municipal bond?
Hey Rahul a total bond fund would not be as tax efficient as a muni bond fund. The intermediate muni bond fund from vanguard is a good choice. Are you in a state with income tax? you can do a state specific muni bond fund if you really want to avoid taxes at the state level as well. Of course that means a little more default risk.
If you really feel you want to also limit the amount of interest rate risk, then choose a short term bond fund.
If you’re in a lower tax bracket or if it is held in a retirement account, then TBM is great.
Can we agree on three points? (1) I am fully responsible for the capital gains driven by my own actions (i.e. my selling) inside my Vanguard account. (2) I am also responsible for the gains driven by account managers watching over their respective funds (assuming they are reasonably reliable and consistent year over year in their actions). (3) I should not have to bear capital gain consequences caused by the Vanguard marketing team! VFORX, VWILX, VSCGX all had large year over year increases in their Capital Gain Distributions…it wasn’t just one fund! I certainly don’t accept the rationale these holdings should only be in deferred accounts. What funds will Vanguard mess with next year? After being a long term Vanguard investor, I am now exploring options to leave.
I agree with the three points you make. I do not think Vanguard will make this move again, especially since they changed the handling of this midway through by just merging the shares rather than compelling the institutional investors to sell their retail shares to buy the institutional shares (so they’ve proven they know now how to make this alteration correctly). Vanguard will have a hard time to effectively defend their actions if only from a PR standpoint. I find it so annoying how people keep blaming those of us who kept a TD fund in a taxable account when it was not our actions, but rather those of Vanguard, that caused this capital gains nightmare.
This was a costly “mistake” for many of us. I ended up with a tax bill of about $15k in unexpected fed and state taxes combined. Luckily, I’m fairly new to investing so my tax hit was not nearly as bad as others that had a million or more in taxable account TDFs. Yesterday, I finally exchanged my TDF to 100% VTSAX at a paper loss of -$23k. This will force me to finally learn about tax loss harvesting next year, and if I feel comfortable doing it (using MilTax H&R Block), I may just keep TLH for years to come and recoup the money lost, and then some. Consequently, my kids will eventually learn about not having TDFs in their taxable accounts and how to TLH. All in all, a powerful lesson. My plan all along was to hit the “Easy Button” and forget about it until retirement. Now I have to be a little more actively involved with my finances. I intent to keep TDFs in my TSP and Backdoor Roth IRAs for now, with VTSAX in my taxable. Hopefully keeping a one-fund portfolio in my taxable account will be okay and easy enough while I continue to learn.
Hey Miguel I’m so sorry this happened to you and others 🙁 but sounds like your response will more than make up for that $15k tax bill. Also, how about just putting all your TDF’s in the TSP and make the backdoor Roth have all VTSAX. that way all the slow growing bond portion of your asset allocation will actually partly owned by uncle Sam, while you enjoy the full growth of VTSAX in Roth! that is assuming you have enough space in the TSP to put all your bond allocation using a TDF, but if not I would suggest a TDF and a bond fund in the TSP.
Kind of nuanced to think about but realize that this is taking more risk putting all your bond portion in your TSP as basically the government is sharing the risk with you like a silent partner in a TSP. But that’s the point! You have just increased your return and your brain doesn’t perceive the increased risk 🙂
I got totally screwed. I used the retirement fund as an easy way to invest extra cash that I couldn’t put into a retirement account. I had this fund for over 10 years and then took a massive tax hit. I am really frustrated about this. I’m closing my vanguard account.
You’re not alone (as you can see above).
I was wondering if I should have both of our Roth IRAs in 100% VTSAX as well so I think I may pull the trigger. Keep the TDF in the TSP and everything else (Roth and taxable) in VTSAX. I definitely need to continue my CFE so that eventually all of this makes more sense.
What does your written investment plan say?
https://www.whitecoatinvestor.com/investing/you-need-an-investing-plan/
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
CFE is what you do after you have a plan. Right now you need IFE.
Hey Miguel yeah dude definitely fill up both Roth’s with VTSAX. You got it, it’s best to put your highest growing assets in Roth so the government can’t take a portion of that high growth away, while a TDF which has a slow growing bond portion is best in tax deferred.
and I echo the wise Jim Dahle- make sure that you have done your initial financial education and have a written financial plan, which should state something about this asset location business of putting TDF in tax deferred and highest potential growing assets in Roth.
I got slapped on my VG TR2025 fund in my taxable account too. I max out my ROTH/401K so had no choice but to use the taxable account. I’m a set it and forget it guy so this was extremely annoying.
Normally I have to pay CG tax on $1500 – $3500 but on Dec 29, 2021 my CG $23K. WTH? My account has been set to re-invest CG for 9 years but had I known this was coming I would have changed the account to dump it into Money Market Fund so I could subtract an amount to pay the taxes.
What’s more, on Dec 28th the TR2025 fund was selling for $23.67 pr/share. On Dec 29th the share suddenly dropped to $20.34 pr/share so in effect, Vanguard cached out those shares at a $3.33 /share loss only to turn around and re-invest it. Who did that benefit other than Uncle Sam?
To those in the comments saying not to invest mutual funds in a taxable account and we should have known better, etc. I say this. Target Retirement funds are supposed to be for set it and forget it inventors that Vanguard manages. TR 2025 has these underlying funds. I’m supposed to know these have mutual funds?
VTBIX Vanguard Total Bond Market II Index Fund
VTSMX Vanguard Total Stock Market Index Fund
VGTSX Vanguard Total International Stock Index Fund
VTIEX Vanguard Total International Bond II Index Fund
VTIPX Vanguard Short-Term Inflation-Protected Securities Index Fund
Vanguard betrayed my trust. They’re the experts managing the TR funds, not me. I have now changed any Dividends and CG in my taxable account to NOT re-invest and I will be looking to divest from TR2025 in my taxable account, hopefully with out taking another HUGE CG hit.
Mike, if you have been reinvesting gains and dividends for 9 years and with the low price of the 2025 TRF currently, there is a good chance that you could sell your entire holdings and harvest a capital loss (to offset future Vanguard unexpected gains distributions from other vanguard mutual funds).
I have IRA $ invested in several of the Vanguard target date funds. The above article/comments are all about whether people were affected by taxable distributions of long term capital gains. I was not since all my holdings were in Regular and Roth IRAs. But, here’s what I don’t understand. Now I am holding investments with huge losses and, if I had to cash out any of these funds for distributions, I would reap those losses. As of right now, it just makes my investment portfolio look terrible and I am wondering if the value will ever go up again. Anybody have any thoughts/comments about this?
The value of stocks and bonds goes up and down. That’s why you earn more there than your savings account. Over the decades, it generally trends up significantly. The moral of the story is that you shouldn’t invest money you need any time soon into stocks and bonds. And if you don’t need the money any time soon, why are you concerned that they went down in value over the last six months? Target retirement mutual funds just own stocks and bonds. So when stocks and bonds go down, the value of your funds will go down.
You are correct and I will be holding onto the funds. I just hate looking at those big losses sitting there every time I look at my account.
Historically, markets have always eventually rebounded, and I try to keep that in mind but in light of how things are, I’m not doing a good job of it. Part performance is no guarantee of what is going to happen this time around. If the economy does completely tank, we’re all screwed.
WSJ announced that Vanguard is going to pay $6 million to investors for this screw-up. Make sure you get yours. $6 million won’t go very far though given how many people this affected.
https://www.wsj.com/articles/vanguard-to-pay-6-million-to-investors-hit-with-big-tax-bills-11657133751?mod=lead_feature_below_a_pos1
Sadly I don’t reside in Massachusetts…
A Vanguard Group subsidiary will pay about $6 million to Massachusetts investors who were whacked last year with unexpectedly painful tax bills.
Massachusetts securities regulators on Wednesday reached a $6.25 million settlement with Vanguard Marketing Corp., a subsidiary of Vanguard, following an investigation launched this year into changes the Malvern, Pa.-based financial giant made to its target-date funds.
There will be more I’m sure, one for each state I suspect.
I don’t have a subscription to the WSJ so I cannot read the article. Does this settlement only apply to people in MA? What about everyone else from across the country?
Yes, it only applies to Massachusetts investors, but although it says Vanguard admitted to no wrongdoing, it’s a pretty good sign the class action claims have merit. Here’s a Reuters article that is not paywalled: https://www.reuters.com/legal/transactional/vanguard-pay-millions-mutual-fund-investors-hit-with-big-tax-bills-2022-07-06/#:~:text=NEW%20YORK%2C%20July%206%20(Reuters,face%20surprisingly%20big%20tax%20bills
Yes.
I’m sure there are more coming.