Vanguard's $106 million target-date fund settlement offers a key lesson about taxes

cnbc.com:

There's an important lesson for investors in Vanguard Group's recent $106 million settlement with the Securities and Exchange Commission over its target-date funds: Being mindful of your investment account type can save you from a big tax bill in certain cases.

Vanguard, the largest target-date fund manager, agreed to pay the sum for alleged «misleading statements» over the tax consequences of reducing the asset minimum for a low-cost version of its Target Retirement Funds.

Lowering the asset minimum for its lower-cost Institutional share class — to $5 million from $100 million — triggered an exodus of investors to these funds, according to the SEC. That created «historically larger capital gains distributions and tax liabilities» for many investors who remained in the more-expensive Investor share class, the agency said.

Here's where the lesson applies: Those taxes were only borne by investors who held the TDFs in taxable brokerage accounts, not retirement accounts.

Investors who hold investments — whether a TDF or otherwise — in a tax-advantaged account like a 401(k) plan or individual retirement accounts don't receive annual tax bills for capital gains or income distributions.

Those who hold «tax inefficient» assets — like many bond funds, actively managed funds and target-date funds — in a taxable account may get hit with a big unwelcome tax bill in any given year, experts said.

Placing such assets in retirement accounts can make a big difference when it comes to boosting net investment returns after taxes, especially for high earners, experts said.

«By having to pull money out of your coffers to pay the tax bill, it leaves less in your portfolio to compound and grow,» said Christine Benz, director of personal