Vanguard Agrees to Pay $6.25M For Retail Investor Tax Burden O/A TDF Threshold Lowering

First Western to Pay $200k Fine For Recommending Unsuitable Investment

Massachusetts’ securities regulator has brought charges against Vanguard related to taxable distribution in the target-date oriented funds, to settle which Vanguard has agreed to a payout of $6.25 million.

In December 2020 Vanguard lowered the threshold for investment in its Institutional TDFs to $5 million from the earlier $100 million. This caused a flight of accounts with over $5 million from the standard funds which, in turn, led to the shrinking of those funds’ assets which, in turn, triggered the need to sell some holdings which, in turn, set off capital gains.

The office of William Galvin, the Secretary of the Commonwealth, alleged that TDFs were being peddled by the company “as a hands-off investment option for hard-earned retirement savings” despite them being susceptible to “management decisions such as the reduction of investment minimums.”  Galvin added, “These extraordinary capital gains were caused by Vanguard’s conscious decision to benefit ultra-wealthy shareholders over main street investors.”

Investigating allegations that small investors had incurred large tax liabilities on non-retirement account holdings, letters asking for details on TDFs offered in Massachusetts have been sent to Blackrock Investments, American Fund Distributors, T. Rowe Price Investment Services, and Fidelity Brokerage Services apart from Vanguard, by the office of William Galvin.

The settlement agreed includes a fund of $5.5 million that would be used for eligible Massachusetts customers to receive restitution towards a part of the tax liabilities while $250,000 would be set aside for the purpose of administering the fund. Additionally, a one-time payment of $500,000 would be made to the regulator.

Investor response

According to the Wall Street Journal (WSJ), complaints about the ‘enormous’ tax bills have been taken by Vanguard clients to Bogleheads.com, a platform popular with such investors for such issues. The Journal reported one user who complained of owing $150K in taxes on account of distributions received that amounted to $550K in the Target Retirement 2035 fund of Vanguard.

According to the WSJ, this user apparently posted on the site, “HOW COULD VANGUARD LET THIS HAPPEN??”

A lawsuit was filed in March in the federal court in Philadelphia by a group of impacted retail customers of Vanguard, accusing the company of acting in favor of large retirement plans while disregarding the interest of small investors, by reducing the threshold minimum for their institutional target-date funds.

Investing in Target Date Funds

A target-date fund, also known as age-based, dynamic-risk, or lifecycle funds, is an investment strategy that aims to increase your investments at a specific time in your life. These funds are generally mutual funds or collective trusts. Investing in target-date funds can be a good way to save for retirement and to protect your assets while at the same time taking advantage of current market conditions. In addition to target date funds, there are other types of investment funds that can help you reach your goals.

Investing in target-date funds

While a target date fund is a simple and quick way to invest, you need to consider the risks associated with them. You shouldn’t expect the fund to make money at all times, and the risk may not be worth the potential rewards. Instead, you should invest only in funds that will allow you to reap the rewards when the time comes. For example, if you’re planning on retiring in 2050, you might invest in a target-date fund that will invest only in equities.

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Another disadvantage to target-date funds is that they may carry high fees. Some target-date funds charge more than 0.80% in annual management fees, which compound to make wealth-building more difficult. Some target-date funds may also have large outsized holdings in other asset classes, which can increase their overall weighting in those classes and potentially magnify the impact of their target-date fund. If you’re still uncertain about the risks associated with target-date funds, it’s a good idea to compare the expenses and fees of different target-date funds.

Investment strategies

There are two major investment strategies for target-date funds. These strategies can either be actively managed or passively designed. Active management will invest in various sectors of the market, and passive management will invest in a smaller set of stocks and bonds. The key is to diversify your portfolio so that your investments have a range of risk levels. While active management tends to be more conservative, target date funds can be a smart option for investors looking for diversification.

In addition to the target-date fund performance information, fund providers typically make available additional information on their funds. The information includes a bar chart illustrating annual total returns over the last 10 years, a table that shows average annual total returns for one, five, and ten-year periods, and similar information for the appropriate broad-based securities market index. Investing in target-date funds requires careful monitoring. But if you’re a beginner and don’t have much knowledge about the investment industry, don’t be afraid to seek the help of a financial planner.

Tax consequences

While tax-efficient target-date funds offer tax advantages, they also carry potential pitfalls. Most target-date fund investors own their funds in tax-advantaged accounts. As Vanguard reports, 99% of its target date series investors own their funds in tax-deferred accounts. Thus, tax-free distributions are a non-event for these investors. However, the tax-cost ratio of target-date funds is higher than that of other Morningstar categories.

Another potential downside of target-date funds is that they don’t hold the asset allocation the investor would have preferred. Some funds transition faster than others, which may expose an investor to undue risk. Investors should take a close look at the asset allocation, glide path, and retirement methodology of a target date fund before deciding to invest in one. These features may help to protect against tax implications. Listed below are some potential tax implications of target-date funds:

Glide-path

The first consideration in determining the appropriate glide path is to look at the demographics of the participants of the plan. While most participants withdraw their savings as they approach retirement, many union plans encourage retirees to stay in the plan and continue contributing. But a single glide path may not be enough for your participants if the fund doesn’t offer diversification. For example, a U-shaped glide-path is “To” and “Through” in TDF terminology.

Before committing to a glide path for target-date funds, you should understand its risks and benefits. Although target-date funds are meant to offer diversification and professional management, they do have outliers. While this is not necessarily a problem, it is important to consider whether outliers are an asset class that you’d be comfortable with. By following these guidelines, you’ll be able to balance appreciation with stability.

Returns

When a person invests for retirement, they are often looking for the best returns on their investments. Target date funds are an excellent way to diversify your portfolio and minimize some of the risks that accompany saving for retirement. While some retirement risks are uncontrollable, investing in target-date funds can help you to mitigate these risks through diversification and inflation management. The goal is to have a comfortable and steady income stream when you retire.

Before investing, it is important to monitor the performance of your target-date fund and its risk and reward profile. While your target date may be an excellent starting point, you should look for other important factors before investing. For example, you should consider the fund’s asset allocation, risk level, performance, and fees. All of these factors can be found in the fund’s prospectus. A person’s risk tolerance is the basis for choosing the appropriate target-date fund.

 

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