Dear Dr. Don,
I am planning on making my maximum contribution to my Roth IRA this winter. The fund I will be investing in pays its dividend in late December.
Is there any advantage (or disadvantage) to making my contribution before or after this dividend is paid out? My dividend earnings are automatically reinvested in the fund. I’m just curious if there is any timing issue that can be played to my advantage.
— Scott Strategy
Buying a mutual fund just prior to a distribution out of the fund isn’t generally recommended in taxable accounts because the distribution may have a tax impact for the investor. I say “may” have a tax impact because there are several types of distributions.
IRS Publication 564, Mutual Fund Distributions, describes the different types: “A distribution you receive from a mutual fund may be an ordinary dividend, a qualified dividend, a capital gain distribution, an exempt-interest dividend or a nondividend distribution. The fund will send you a Form 1099-DIV or similar statement telling you the kind of distribution you received.”
Fund companies announce their distribution dates ahead of time and give investors an estimate as to the size and type of distribution the investor will receive.
But, as you point out, you’re investing in the fund within a tax-advantaged Roth IRA account. The mutual fund distribution isn’t taxable to you, and you have the ability to reinvest the distribution back into the fund. The value of a share of the mutual fund should drop by the distribution per share on the day the fund goes ex-dividend (distribution).
I can’t think of a timing strategy in regard to fund distributions that you can use to your advantage when funding the account for the current tax year. If a reader writes in with one, I’ll be sure to pass it along.
Waiting until the end of the tax year to fund your Roth IRA does cost you a year’s worth of investment returns when compared to investing the funds at the beginning of the tax year.
Dollar-cost averaging across the year lessens the impact of committing the funds on one date. Transaction costs are relevant, but may be minimized with an automatic investment plan.
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