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Wealthy Americans fleeing tax increases can switch to a turbocharger to the ETF

(Bloomberg) – The thriving ETF industry may be set to raise even more money in the coming years as wealthy Americans, faced with higher taxes on capital gains, seek to limit what they owe to Uncle Sam. President Joe Biden’s plan to double the rate, which makes more than $ 1

million a year in investment returns, would accelerate a change that has already seen hundreds of billions of dollars migrate from mutual funds to exchange-traded funds, market observers say. This is because ETFs are usually more efficient than taxation, resulting in fewer capital gains payments, which may soon become much more expensive for some. In fact, with one measure, the tax efficiency of the ETF is the single most important driver behind the tectonic change in asset allocation in recent years. Although the administration’s plan remains in its infancy and is sure to face tight control by lawmakers in the coming months, even a gradual increase in capital gains is likely to encourage further use of the ETF, according to David Perlman, ETF strategist at UBS Global Wealth Management. “If the tax rates on capital gains are higher, if you have a choice of structure that helps defer capital gains and gives you more control over when to recognize those gains, you will be more likely to enter this direction, “Pearlman said. When an investor exits a mutual fund, the fund manager must sell the securities to raise cash for redemption. The same investor who leaves the ETF may sell his shares to another investor, which means that neither the fund nor its manager has made a taxable transaction.Meanwhile, the “in-kind” process used to create and repurchase shares in the ETF – in which the ETF issuer exchanges the fund’s underlying securities with a market maker instead of Cash transactions – means that ETFs rarely make taxable sales A December study by researchers at Villanova and Lehigh universities found that ETFs have averaged tax over the past five years weight by 0.92% lower than active mutual funds. In addition, especially for investors with a high net worth, tax considerations outweigh both performance and fees as a major driver of active mutual fund flows and ETFs, the findings show. “There is no doubt that Biden’s plan to increase capital gains tax could be a boon to the ETF,” said Nate Geraci, president of the ETF Store, a consulting firm, by email. “Despite significant gains in market share from ETFs over the past decade, there are still trillions of dollars locked into less tax-efficient mutual funds.” Last year alone, the ETF industry took in nearly $ 500 billion, while mutual funds have lost about $ 362 billion, according to data collected by Bloomberg.ETF AdvantageMost ETFs today transfer almost no capital gains to shareholders. Only 3 of the 585 in the CFRA’s analysis made payments in 2020, Todd Rosenblut, head of the company’s ETF and mutual fund research, said in a report on April 26. In the same period, 37 of the 39 internal mutual funds of T. Rowe Price Group Inc. have earned capital gains, the analysis shows. “We expect more people who mix ETFs and mutual funds to be more inclined to move to strategies to avoid paying higher taxes on capital gains in the future,” Rosenblut wrote. Even investors who are not affected by the higher simply discussing capital gains reminds investors of the industry’s innate tax advantages over mutual funds.Others are not convinced that a higher capital gains rate will go a long way to increasing inflows. Wealthy investors will have to sell their holdings to mutual funds to make the change, causing significant tax liabilities in the process, said Michael Sigmont, head of trade and research at Harvest Volatility Management. “I see that this tax increase does not is good or bad for an ETF, ”he said. Meanwhile, ETFs do not meet any investment needs. The retirement system in the United States remains heavily focused on mutual funds, for example. However, Perlman agrees with Rosenblut that the potential tax change could even affect investors below the $ 1 million annual income threshold. Those who expect to find themselves in the top tax soon “or” fears that the threshold may be lowered along the way are also likely to change their future distributions, “he said.” Incentives apply more broadly than those affected by the proposal, “Pearlman said. For more articles like this, please visit us at bloomberg.com Subscribe now to stay ahead with the most trusted source of business news. © 2021 Bloomberg LP


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