Taxable distributions could have been minimized

For many families—and especially for high-earning professionals —owning actively managed mutual funds in taxable accounts (TOD, joint, or individual) has quietly become one of the biggest wealth leaks in their financial lives.

Every year, thousands of investors walk into tax season blindsided. They didn’t sell a single share, yet they owe huge tax bills—and they can’t figure out why.

The reason is simple:

Traditional mutual funds are structurally tax-inefficient.

And Morningstar’s annual review* of the least tax-efficient mutual funds confirms it. Many well-known active equity funds paid out massive capital-gain distributions—some exceeding 7%, 10%, even 20%+ of NAV in recent years. That means investors owed taxes even if they didn’t make a withdrawal or sell anything.

This article explains why this happens, the misconceptions around “safe” traditional investments, and how your estate can be built using far more tax-efficient structures, strategies, and products.

Why Mutual Funds Are Tax Landmines in Taxable Accounts

1. Capital Gains Are Forced on You

Mutual funds must distribute realized gains from:

• Portfolio turnover (regular manager trading)
• Other investors selling (Mutual fund outflows)
• Rebalancing (Trading to reduce stock concentration)
• Manager changes
• Market volatility

Even if you didn’t sell anything, you can get hit with a surprise tax bill.

Morningstar’s list of “the least tax-efficient funds”* shows how severe this can be. What's extremely disappointing are mutual funds that distribute massive annual gains despite mediocre performance. Imagine your fund loses 30% of its value. At the same time, other competitors make money, and investors dump your underperforming fund to buy the next winning product. The outflows force your fund manager to sell a substantial part of the mutual fund's portfolio.  And now, the managers forced sales become your tax problem even if you made no money!

2. Many Legacy Mutual Funds Pay Advisors for Selling Them (12b-1 Fees)

Most investors have no idea that many mutual funds include a 12b-1 distribution fee, which compensates broker-dealers and fee-based advisors for recommending the product on a continuous basis. The mutual funds also compensate brokers and fee-based advisors with an upfront load fee often exceeding 5%.   

In other words:

Some advisors recommend tax-inefficient mutual funds simply because the fund company pays them.

Not because they’re better for the investor.

Not because they help reduce taxes.

Not because they build a stronger estate.

Just because the fund pays a trailing commission.

This is one of the most overlooked conflicts of interest in the financial industry. >>Learn how Marc's Fee-Only Model avoids this

The ETF Advantage: Superior Tax Efficiency

ETFs are generally more tax-efficient because of:

• The in-kind redemption mechanism (allows removing low-basis shares without triggering taxable gains)
• Lower turnover
• Broader diversification

Many ETFs go years—sometimes decades—without distributing taxable capital gains.

 BUT

 (and this is important)

Not all ETFs are equal.

Some have higher turnover, opaque strategies, or hidden risks.

ETFs must be carefully vetted—

By strategy, structure, underlying index, liquidity, and tax-behavior history.

When done correctly, ETFs can help clients avoid the vast majority of annual taxes, grow more efficiently, and support better long-term estate outcomes.

The Advanced Approach: Tax-Loss Harvesting, Tactical Trading & Better Estate Design

Truly tax-efficient portfolios require more than just buying ETFs.

 

1. Tactical Trading to Minimize Realized Gains

Buying the right assets at the right time and coordinating sales ensures that taxable events are minimized across the year.

2. Tax-Loss Harvesting

Loss harvesting can significantly reduce tax liabilities—sometimes to zero—even in positive years.

This is one of the most powerful tools for high-net-worth investors.

3. Estate Planning Strategies That Delete Future Taxes

With proper estate design, assets can receive:

• Step-up in basis
• Tax-efficient ownership across generations
• Reduced estate tax exposure
• Better income-tax positioning for heirs

Most families accidentally destroy estate efficiency simply by holding assets in the wrong location or structure. They may have charitable donations or gifts, but fail to maximize their tax benefits.

Marc Alan Wealth Management builds multi-layered strategies that coordinate portfolio management with estate planning to maximize multigenerational outcomes. >>Ask us how mixing your investments with estate planning can save you some serious tax dollars.

Modern Alternatives: Option-Based, Low-Risk, Tax-Efficient Strategies

Many investors leave large amounts of cash or short-term bonds in taxable accounts—assuming they’re “safe.”

But in recent years, cash equivalents and bond funds in taxable accounts have created shocking tax bills for new clients and prospects.

We frequently see:

• Huge ordinary income taxes from bond interest
• Large capital gain distributions from bond mutual funds
• Poor after-tax returns
• Estate values damaged by lack of compounding

More tax-efficient cash alternatives exist.

Some products use options-based strategies (e.g., covered calls, buffer ETFs, defined-outcome strategies) that provide:

• Lower volatility
• Smoother returns
• Much lower taxable distributions
• Better after-tax performance than cash or muni bonds in many scenarios

 

These can be excellent tools when used properly.

The Myth of Municipal Bonds: “Tax Free” Doesn’t Mean Efficient

Many high-earners overload on municipal bonds, believing they are the most tax-efficient choice.

But in many cases:

• Returns are significantly lower than alternatives
• “Tax free” interest often fails to keep up with inflation
• Over-concentration in munis slows estate growth
• Long-term wealth potential is drastically reduced
• They create opportunity cost far larger than the tax savings

 

Owning too many munis is often a tax-inefficient estate decision, especially for multi-generational planning.

Build a Superior, Tax-Efficient Estate With Marc Alan Wealth Management

If you want a smarter way to invest in taxable accounts—one that reduces taxes every year and builds the strongest long-term estate—you need a coordinated plan that blends:

 

• High-quality ETF selection
• Tactical trading
• Tax-loss harvesting
• Estate structure optimization
• Tax-efficient product vetting
• Cash and fixed-income alternatives that minimize taxes
• Smart use of growth assets in the right account types

 

 At Marc Alan Wealth Management, this is exactly what we specialize in.

 

We’re happy to teach you, guide you, and help you build a superior tax-efficient estate.

You deserve an advisor who protects you not only from market risk—but also from avoidable tax risk.

Schedule a consultation today to learn how we might be able to stop most of your taxable distributions and even mitigate your RMD burdens. Feel you are stuck in an unwanted highly appreciated asset, explore a QOZ >>>Get capital gain tax delayed and paid

* Morningstar.com "Which Funds Are Paying Out Big Distributions" Stephen Welch Nov 13, 2025

Disclosure: This content is for informational purposes only and should not be considered financial advice. Past events are not indicative of future ones; there is no guarantee that any future events will happen. All investments carry risk, including loss of principal. Marc Alan Wealth Management is not responsible for any decisions made based on this content. AI was used to assist in drafting this article for efficiency and clarity.