Vanguard Target Date Funds and Adverse Tax Consequences
Recent changes to Vanguard Target Date Funds left some individual investors with an unexpected and large tax liability. Vanguard has long been considered a fee-friendly platform for individual investors seeking mutual funds and variable insurance products. However, recent changes have left some individual investors with higher than anticipated tax liabilities.
Vanguard Target Date Funds (TDF)
Vanguard is well-known for its customer-centered DIY investment planning. Many individual investors want something that’s hands-off instead of something that needs frequent tending. Target-Date Funds are suitable for these types of investors. They can put “all of the eggs in one basket” and let their TDF run on its own. Investors appreciate this popular “set it and forget it” investment plan. A TDF typically starts when someone begins investing and has an end-date set by the investor. Most use the person’s expected retirement date, but it can end at any time. Many set the end date for events such as a child (or grandchild) starting college.
Portfolio managers design a TDF with higher risk at the beginning, and gradually lowering risk as the fund progresses. The investments start out with mostly stocks and a smaller amount of bonds. Over time, the TDF becomes more conservative in its investing, and the balance shifts to more bonds than stocks. The purpose is to gradually reduce the risks the closer an investor gets to retirement or other end date, and ideally with increased returns. The target-date funds offer that option to both individual retail investors and to larger institutional investors. The TDF tends to be more expensive for individuals because the funds that go into a TDF, such as a 401(k), are tax-deferred—that is, there is no tax due until the money is withdrawn. Some of the monies in Vanguard Target Date Funds were from retirement funds and not subjected to taxes. But money that was not from retirement funds were. Vanguard’s institutional investors were required to have at least $100 million to invest in a TDF, leaving individual investors with a more costly standard version.
In December of 2020, Vanguard lowered that requirement to just $5 million. Hundreds of institutional investors were interested. They were required to sell their investments to move their monies to the less expensive version. For larger corporate and institutional retirement plans, this was a gift. It led to a wave of sales and transfers to the less-costly alternate. But for the investors who stayed and had money in taxable accounts, they were required to support the funds themselves. Two of the retail funds were required to sell some of their holdings because of the large selloff. This triggered capital gains for the smaller number of remaining investors who had their funds in these taxable accounts. Investors were not notified that this was a possibility, nor that they could find themselves with capital gains taxes. Although this was briefly mentioned in the summary prospectus, it wasn’t on any of Vanguard’s websites. Nor did any of the asset managers mention this fact to investors. This has triggered investor lawsuit(s).
Eventually, the company did merge the funds, but not after investors were forced to pay these unexpected tax bills. However, the litigation is ongoing.
The Massachusetts Securities division also began its own investigation into these sudden surprises for Vanguard Target Date Funds investors. The investigation included Vanguard, as well as T. Rowe Price Investment Services, American Fund Distributors, BlackRock Investments, and Fidelity Brokerage Services. Recently, Vanguard settled with the state for $6.25 million. In the settlement, the company agreed to pay up to 65% of most of the investors’ bills. The settlement included a $500,000 payment to cover the cost of the investigation, and $250,000 to administer the payments to the qualified investors. The company neither admitted nor denied any of the allegations.
Contact Colling Gilbert Wright PLLC Today
Colling Gilbert Wright PLLC represents Investors In FINRA Arbitration Claims Against broker/dealers and other investment platforms such as Vanguard when an identifiable cause of action exists. An individual arbitration claim may make sense for larger investors facing substantial tax bills. Securities or FINRA arbitration is intended to be faster and less expensive than a class action and could result in a better return in a shorter period of time. Our firm will analyze your potential claim at no charge and will only charge a fee/costs if there is a recovery. Please contact us today for a free evaluation. Thank you.