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One involves liquidating assets, while the other reorganizes them

Reviewed by Pamela Rodriguez

Chapter 7 vs. Chapter 11: An Overview

Companies that find themselves in a dire financial situation where bankruptcy is their best—or only—option have two main choices in the U.S.: Chapter 7 bankruptcy or Chapter 11 bankruptcy. Both are also available to individuals.

Under a Chapter 7 bankruptcy, the business closes its doors and its assets are sold off to pay its creditors. In a Chapter 11 bankruptcy, the company may continue to operate under court supervision.

Key Takeaways

• Chapter 7 and Chapter 11 are two common forms of bankruptcy.
• In a Chapter 7 bankruptcy, the assets of a business are liquidated to pay its creditors, with secured debts taking precedence over unsecured debts.
• In a Chapter 11 bankruptcy, the company continues to operate under the supervision of a court-appointed trustee, with the goal of emerging from bankruptcy as a viable business.

Chapter 7

Chapter 7 bankruptcy is sometimes called liquidation bankruptcy. Businesses going through this type of bankruptcy are past the stage of recovery and must sell off assets to pay their creditors. The process works much the same for individuals.

The bankruptcy court will appoint a trustee to ensure that creditors are paid off in the right order, following the rules of “absolute priority.”

Secured debt takes precedence over unsecured debt in bankruptcy, and the holders of secured debts are first in line to be paid off. Loans that are secured by a specific asset, such as a building or a piece of expensive machinery, are examples of secured debt.

Whatever assets and cash remain after all the secured creditors have been paid are pooled together and distributed to creditors with unsecured debt. Those would include bondholders and shareholders with preferred stock.

To qualify for Chapter 7 bankruptcy, the debtor can be a corporation, a small business, or an individual.

Individuals are also eligible for another form of bankruptcy, Chapter 13, in which the debtor agrees to repay at least a portion of their debts over a three- to five-year period under court supervision.

Chapter 11

Chapter 11 bankruptcy is also known as “reorganization” or “rehabilitation” bankruptcy. It is the most complex form of bankruptcy and generally the most expensive. For that reason, it’s most often used by businesses rather than individuals. The business may be corporations, partnerships, joint ventures, or limited liability companies (LLCs).

Unlike Chapter 7, Chapter 11 gives a company an opportunity to reorganize its debt and try to reemerge as a healthy business.

A Chapter 11 case starts with the filing of a petition in a bankruptcy court. The petition may be a voluntary one, filed by the debtor, or an involuntary one, filed by creditors who want their money.

During Chapter 11 bankruptcy, the business will keep operating while taking initiatives to stabilize its finances, such as cutting expenses, selling off assets, and attempting to renegotiate its debts with creditors—all under the court’s supervision.

The Small Business Reorganization Act of 2019, which went into effect on February 19, 2020, added a new subchapter V to Chapter 11 designed to make bankruptcy easier and faster for small businesses, which the U.S. Department of Justice defined as “entities with less than about $2.7 million in debts that also meet other criteria.” The act “imposes shorter deadlines for completing the bankruptcy process, allows for greater flexibility in negotiating restructuring plans with creditors, and provides for a private trustee who will work with the small business debtor and its creditors,” the Justice Department says.

Note

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law on March 27, 2020, made temporary changes to bankruptcy laws designed to make the process more available to businesses and individuals economically disadvantaged by the COVID-19 pandemic. These changes ended, for the most part, in March 2021.

Chapter 7 vs. Chapter 11: Key Differences

Like Chapter 7, Chapter 11 requires the appointment of a trustee. However, rather than selling off all assets to pay back creditors, the trustee supervises the assets of the debtor and allows the business to continue.

It’s important to note that debt is not absolved in Chapter 11. The restructuring only changes the terms of the debt, and the company must continue to pay it back through future earnings.

If a company is successful in Chapter 11, then typically it will be expected to continue operating in an efficient manner with its newly structured debt. If it is not successful, it will file for Chapter 7 and liquidate.

Chapter 7

• Known as “liquidation” bankruptcy

• Assets are sold off by a trustee to pay debts

• When all assets are sold, the remaining debt generally is forgiven

• Used by both businesses and individuals

Chapter 11

• Known as “reorganization” bankruptcy

• Debts are restructured by a trustee, and the business continues

• Remaining debts must be paid back through future earnings

• Used primarily by businesses

How to Prevent Bankruptcy

Bankruptcy is generally a last resort for businesses and individuals alike. Chapter 7 will, in effect, put a business out of business, while Chapter 11 may make lenders wary of dealing with the company after it emerges from bankruptcy. A Chapter 7 bankruptcy will remain on an individual’s credit report for 10 years, and a Chapter 13 for seven.

Bankruptcy can be unavoidable. A business can go under during a severe recession. An individual can suffer a job loss or crushing medical expenses.

Still, many bankruptcies could have been avoided. One key, for both businesses and individuals, is to borrow judiciously. For a business, that could mean not expanding too rapidly. For an individual, it might mean not buying a larger home or a costlier car.

Before filing for bankruptcy, a business owner should consult with an outside attorney who specializes in bankruptcy law and discuss the alternatives.

Individuals are required by law to take an approved credit counseling course before they file. They may also have other resources available, such as a reputable debt relief company that can help them negotiate with their creditors. Investopedia publishes an annual list of the best debt relief companies.

Can You File for Bankruptcy Without an Attorney?

Individuals can file for bankruptcy under Chapter 7 or Chapter 13 without an attorney, according to the website of the U.S. federal courts system. This is called “filing pro se.”

However, the site strongly recommends seeking the help of a qualified attorney “because bankruptcy has long-term financial and legal outcomes” and misunderstandings or mistakes can have serious results.

Who Can File Chapter 11?

Chapter 11 bankruptcies can be filed by any individual, business, partnership, joint venture, or limited liability company, with no specific debt-level limits and no required income.

What’s the Difference Between Chapter 11 and Chapter 13?

Both Chapter 11 and Chapter 13 allow for the discharging of debts but have different costs, eligibility, and time to completion, making them two different types of bankruptcies.

• Chapter 11 can be done by almost any individual or business, with no specific debt-level limits and no required income.
• Chapter 13 is suitable for individuals with stable incomes, and this type of bankruptcy sets specific debt limits.

The Bottom Line

Chapter 7 and Chapter 11 are two common options for businesses to declare bankruptcy.

Chapter 7 is considered a liquidation bankruptcy: it doesn’t require a repayment plan but the business has to sell some assets to pay creditors.

Chapter 11 is considered a reorganization bankruptcy that allows businesses to maintain their operations while creating a plan to repay creditors.

Reviewed by Lea D. Uradu

Lien vs. Encumbrance: An Overview

A lien represents a legal right to take possession of someone else’s property until a debt is repaid or an obligation is met. It’s a means of securing payment—the settlement of an obligation from the property owner. By contrast, an encumbrance is a much broader term that refers to any type of claim against a property. A lien is one kind of encumbrance, but not all encumbrances are liens.

Key Takeaways

• A lien is a monetary claim against property intended to ensure payment.
• Any lien is an encumbrance, but the reverse is not always true.
• Encumbrance refers to any claim against a property, not just one to ensure payment.

Liens

A lien is a legal right granted by the owner of a property, by a law, or otherwise acquired by a creditor. A lien serves to guarantee an underlying obligation, such as the repayment of a loan. If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien.

Liens always represent a financial interest. A lien often results from secured loans such as auto loans and mortgages. It effectively gives the creditor the right to seize and sell the property that the creditor has a lien against to satisfy the outstanding debt.

A common example: If a person fails to make the payments on a car loan, it can lead to the financing company repossessing and selling the car to obtain payment. Another type of common lien is a judgement lien resulting from a lawsuit initiated by a creditor. Upon winning the suit, a creditor can have a lien placed on the debtor’s property in order to facilitate repayment of the debt. Liens may even include the right to attach funds in the debtor’s bank account.

Liens attached by tax agencies are specifically referred to as tax liens. A federal tax lien is notable in that it takes precedence over any other claims by creditors, in most cases.

Important

Home buyers need to be aware of any encumbrances on a property before they make a purchase. A title search should bring to light any outstanding claims or liens.

Encumbrances

An encumbrance is a claim against a property by a party that is not the owner. It can affect the transferability of the property and restrict its free use. Most, but not all encumbrances relate to real estate. Here are a few common types.

Easement

A easement is a real estate concept that defines one party’s rights of use or improvement of someone else’s property. An affirmative easement allows the easement holder to use the property according to the easement’s terms. An example: a public utility company may have the right to erect telephone poles or run pipes either above or beneath private property. A negative easement lets the easement holder prevent certain actions. For example, a neighbor may have the right to stop their next door property owner from mowing their lawn at certain times or on certain days of the week.

Encroachment

An encroachment is an encumbrance that involves a party who is not the property owner intruding on or interfering with the property—for example, by building a wall that crosses the lot line. Until the issue is resolved, the property with the encroachment is encumbered, or can’t be freely used.

Lease

When someone rents a property for a specified time period and rate, it’s a type of encumbrance for the landlord, who retains title to the property but is constrained from using it by the lease agreement.

Special Considerations

Liens and encumbrances are most commonly associated with real estate, but either one may be applied to personal property as well. If an individual fails to pay a debt, a creditor or tax agency may attach a lien or an encumbrance to the individual’s property, such as a car or boat. Having such a claim against the property creates an unclear title and can limit the ability to sell or otherwise transfer the property.

Any existing encumbrance is required to be disclosed by the owner of the property to potential buyers. A buyer will inherit the encumbrance upon purchasing the property. A seller who does not disclose existing encumbrances is subject to legal action by the buyer for their failure to do so.

What Is a Restrictive Covenant?

This is a type of encumbrance that curtails how a property can be used. Deed restriction is another term for a restrictive covenant. Homeowners associations (HOAs) often have restrictive covenants that may, for example, forbid using a certain type of fencing around a yard or the running of a small business in the home.

What Does It Mean to Own a Home Free and Clear?

Owning a home free and clear means that the property has no legal encumbrances. That means the homeowner has paid off their mortgage and there are no outstanding liens against the home. It also means there are no encroachments or deed restrictions on the property. Another term for this is having clear title.

Can Zoning Laws Be Encumbrances?

Yes, zoning laws and environmental regulations can be encumbrances in that they may prohibit specific uses or improvements to the land. If a part of the property is in a designated wetland area, for example, state or local law may prohibit the development of that part of the property.

The Bottom Line

Encumbrances encompass more claims on property than liens do. Some are financial, some are not. But a lien is tied to a debt obligation, which allows the lien holder to seize collateral property if the debt is not paid in a timely fashion. A common type of lien is a mortgage, under which a mortgagee who has agreed to pay off the debt on a home can be forced to forfeit the property if they cease making payments.

Fact checked by Suzanne Kvilhaug
Reviewed by Lea D. Uradu

People who have reached their 50s may wonder if it’s too late in life for them to commit to a mortgage and purchase a home. Years ago, the answer would likely be yes.

However, growing numbers of Americans are working, or plan to work, well beyond the traditional retirement age of 65 in order to maintain a comfortable income. And, whether they’re working or retired, the increase in life expectancy means that most people in their 50s have many years of life ahead of them.

Below are some reasonable questions you might ask yourself before signing up for a new mortgage. Most are relevant to people of any age but they are particularly pertinent to people in their 50s.

Key Takeaways:

• Older homebuyers, now in their peak earning years, might consider a 15-year mortgage or even a shorter term in order to pay it off before they retire.
• Empty-nesters might consider where they really want to live long-term.
• Maybe it’s time to downsize, or at least right-size your home to fit your needs now.

1. How Big a Home Do You Need?

It’s not always wise to buy the biggest home you can afford, particularly if your children have grown up or soon will. Big houses are expensive to heat and cool, labor-intensive to maintain and clean, and their property tax bills are bigger as well.

On the flip side, a bigger home will allow you to accommodate grandkids for overnight visits.

2. Is a Short-Term Mortgage Better?

For those purchasing a home in their 20s and 30s, a 30-year mortgage is the obvious financing choice—in part, because people of that age don’t usually have the financial means to make the higher payments associated with shorter-term loans.

But people in their 50s might opt for a 15-year mortgage. They should be in their peak earning years. They’ll want to make sure they pay off the loan while they’re still working. For that matter, they won’t want to be forced to put off retiring because of the burden of a mortgage.

A mortgage calculator is a useful tool to budget these costs.

3. Pay Off the Mortgage or Save for Retirement?

Americans at any age are struggling to maintain a balance between a good standard of living now and sufficient savings for retirement down the road. When you’re in your 50s, buying a house might cut into your retirement savings significantly, if it pushes your living costs up much higher.

Maximizing your retirement contributions may ultimately net you more money than the cash you’d save by paying off a mortgage in the 15 or 20 years before you retire.

Once you hit 50, your annual contribution limit to an individual retirement account (IRA) increases by $1,000 over the $7,000 standard limit in 2025. For 401(k) plans, people aged 50 and over can contribute $7,500 more than the standard $23,500 limit as of 2025.

That’s a recognition by the IRS that you may need what it calls a “catchup contribution” to boost your retirement savings.

4. Where Will You Live?

Location significantly influences home prices. A house in St. Louis is going to cost much less than an identical home in San Francisco.

If you’re not inclined to move across the country, consider price differentials across different neighborhoods in your area. But keep in mind that homes in more remote areas may be cheaper, but they might not be the best choice for commuters. 

5. How Is Your Health?

If you or a family member has expensive medical issues, you may need to allocate your savings to medical expenses rather than to a new home.

This is another good reason to avoid overspending on housing.

6. How Often Do the Kids Visit?

If your extended family visits often, buying a larger home with plenty of bedrooms makes sense. But if your family only visits every few years, paying for hotel rooms is more economical than paying off the mortgage on a large home.

7. When Is the Right Time?

If you have children who are in college or will be soon, you might avoid buying a new home for now. Unless, that is, you plan to downsize, in which case some of the money from selling the old house can be used to cover tuition expenses.

Is It Difficult for an Older Homebuyer to Get a Mortgage?

Yes. Applications to finance or refinance a home are more likely to be rejected if the applicant is older.

A 2023 white paper by economist Natee Amornsiripanitch, of the Federal Reserve of Philadephia, says that the probability of rejection of a mortgage application climbs steadily with the age of the applicant and accelerates in old age. If they are approved, they tend to pay slightly higher interest rates. In fact, age appears to be as likely a barrier to a mortgage application as race and ethnicity.

Isn’t Discrimination Against Older Mortgage Applicants Illegal?

You bet. It’s illegal to reject any loan applicant on the basis of age. But there are a number of legally permissible factors that work against older applicants. These include:

• The length of time you are likely to continue having your present income.
• The sources of your income. (Investment income is considered a bit riskier than earned income.)

On the other hand, some of the criteria for approval favor older applicants. For example, people in their 50s usually can show a longer history of successfully handling credit.

Can a 70-Year-Old Get a 30-Year Mortgage?

Yes. There is no age limit to a mortgage application. If you have a substantial down payment and a steady income (which can include pension and Social Security payments), you have a good chance of approval regardless of your age. As noted above, there’s a high rejection rate for older applicants but you can get past it with better-than-usual qualifications that will get you past that age barrier, such as a higher down payment and substantial savings.

The Bottom Line

If you’re in your 50s, it’s not too late to buy a new home, but it’s key to ask the right questions and make the wisest decisions possible. Above all, avoid getting stuck making mortgage payments years into your retirement.

Reviewed by Lea D. Uradu
Fact checked by Hans Daniel Jasperson

Mortgage lenders usually verify your employment by contacting your employer directly and reviewing recent income documentation. The borrower must sign a form authorizing an employer to release employment and income information to a prospective lender. At that point, the lender typically calls the employer to obtain the necessary information.

Employers are usually happy to help, but there are steps borrowers can take if they refuse to verify employment.

Key Takeaways

• Mortgage lenders verify employment by contacting employers directly and requesting income information and related documentation.
• Most lenders only require verbal confirmation, but some will seek email or fax verification.
• Lenders can verify self-employment income by obtaining tax return transcripts from the IRS.
• There are several steps that borrowers can take if employers refuse to verify employment.

The Verification Process

In general, lenders verbally verify the information borrowers provide on the Uniform Residential Loan Application. However, they may opt to confirm the data via fax, email, or a combination of all three methods.

Mortgage lenders use this information to calculate several metrics to determine the likelihood that a borrower will repay a loan. A change in employment status can have a significant impact on the borrower’s application.

Additional Information

When verifying employment, a lender will frequently ask other questions as well. The lender may inquire about the likelihood of continued employment.

Lenders are also interested in verifying position, salary, and work history. While lenders usually only verify the borrower’s current employment situation, they may want to confirm previous employment details. This practice is common for borrowers who have been with their current company for less than two years.

Verification for Self-Employed Individuals

Many people who take out mortgages are self-employed. In this situation, lenders often require an Internal Revenue Service (IRS) Form 4506-T. This form is a request for “Transcript of Tax Return” and allows the lender to receive a copy of the borrower’s tax returns directly from the IRS. In a self-employed situation, the lender may also ask for attestation by a certified public accountant (CPA) to confirm income.

Responding to a Refusal to Verify Employment

It is frustrating when an employer will not verify employment, but it can be easy to fix this situation in some cases. The first thing to do is tell your employer’s human resources (HR) department that you need verification.

Some companies will not give out employment-related information without your permission. This policy is designed to stop sensitive information, such as your salary, from falling into the hands of criminals.

Important

Don’t give up or get angry if an employer will not verify your employment. There are usually ways to deal with this problem or work around it.

There can also be state laws or company rules against sharing particular employment-related information. Talk to your employer to determine if some general rule prevents them from sharing. If so, ask them to explain that to your prospective mortgage lender. Some lenders might be willing to process an application if they understand that another state’s laws prevent them from verifying certain information.

You may also be able to find a different mortgage lender. The best mortgage lenders might be more familiar with your state’s laws or willing to work with your employer’s policies.

Finally, there are some cases where an employer will not verify employment for other reasons. At this point, it might be time to consider getting a new job. Why won’t the employer verify your employment? Could they be doing something illegal? Does your employer have something against you? In the long run, you will likely be better off getting out of such a bad situation as soon as possible.

At What Point in the Mortgage Process Does a Lender Ask for Employment Verification?

When you apply for a mortgage, you’ll typically give the lender some financial information, including your employer and income. The lender will verify this information during the underwriting process in order to approve you for a mortgage. That process happens days to weeks before closing. However, since mortgages can take a month or two to settle, the lender may perform a second verification of employment closer to the closing date, to make sure your circumstances haven’t changed in that time.

What Happens if a Lender Cannot Verify Your Employment?

It is possible for a loan to be denied during the underwriting process, so you’ll want to do everything you can to make sure that doesn’t happen. If the lender can’t verify your employment through the human resources department, be sure to call the department and explain your situation. You can also ask the lender whether supporting documentation, such as recent paystubs, tax returns, and W-2s, will be sufficient.

What Happens if I Lose My Job or Get a New Job When Trying To Get a Mortgage?

Tell your lender right away if you lose your job during the mortgage approval process. You have an obligation to make sure your mortgage application is true and complete, and a change in employment will be of interest to your lender. Unfortunately, losing your job may affect whether your loan moves forward, but by informing your lender, you may be able to work out an alternative plan.

The Bottom Line

Mortgage companies verify employment during the application process by contacting employers and by reviewing relevant documents, such as pay stubs and tax returns.

You can smooth the employment verification process by speaking with your HR department ahead of time to let them know to expect a call from your lender. If you’re self-employed, you can have your income attested by a certified public accountant and provide IRS Form 4506-T to confirm your employment.

Reviewed by Robert C. Kelly

The marginal propensity to consume (MPC), or the ratio of the change in aggregate consumption compared to the change in aggregate income, is a key component of Keynesian macroeconomic theory. In the United States, it tends to be higher than many other countries around the world. This also means Americans tend to save less than the citizens of other countries.

Key Takeaways

• Marginal propensity to consume (MPC) is a measure of the rate of household spending.
• MPC is equal to the portion of newly earned income that is spent on consumption rather than saved.
• Historically, the U.S. has had relatively higher MPC than other countries, and therefore a lower saving rate.

Marginal Propensity to Consume

Economists and statisticians often approximate the marginal propensity to consume in the United States at between twenty and ninety percent, with a higher consumption associated with long-term changes in income. This is different than the average propensity to consume (APC), which is lower in the United States than many countries. While APC measures the portion of all income used for consumption, MPC measures the change in consumption given an increase in income.

For instance, suppose you receive a $1,000 bonus on top of your typical annual earnings. You suddenly have $1,000 positive change in income that you did not have before. If you decide to spend $400 of this marginal increase in income on a new suit and save the remaining $600, your marginal propensity to consume will be 0.40 ($400 divided by $1,000).

This higher level of consumption relative to new income is a well-studied phenomenon and has played a key role in economic policy, such as in crafting tax cuts and the low-interest rate policies 1990s and mid-2000s. In fact, marginal propensity to consume figures actually undersell the spend-heavy habits of Americans because they ignore credit cards and home equity lines of credit.

3.8%

The average percentage of Americans’ disposable income that is kept as savings.

Variations in MPC

It is often speculated that the marginal propensity to consume is higher for poorer individuals than wealthy individuals. This is because basic physical comforts, such as food, shelter, clothing and entertainment, make up a larger fraction of a poor person’s income. This tendency is not universal among people or countries. Some wealthy nations, such as Japan and Germany, have relatively low marginal propensities to consume. Likewise, many poor African and Asian countries have relatively high marginal propensities to consume.

The United States, however, is a unique case. Since the U.S. dollar is a de facto reserve currency for many central banks, Americans can essentially trade dollars for cheap foreign goods without ever having to produce an equivalent amount of goods in return. This means American savings rates can be artificially low.

U.S. vs. Rest of the World

The insurance company Allianz has estimated the average marginal propensity to consume based on select countries, which are represented below:

What’s the Difference Between MPS and MPC?

The marginal propensity to consume (MPC) represents how much of each additional dollar of income an individual will spend on consumption. The marginal propensity to save represents how much of each additional dollar an individual will save. Together, these two metrics should add up to 100%.

What’s the Difference Between MPC and the Savings Rate?

Both the marginal propensity to consume (MPC) and savings rate reflect the amount of a household’s income that is spent rather than saved. There are two main differences: First, the savings rate is based on the average savings as a percentage of existing income. Second, the MPC reflects the extra spending associated with an increase in income.

What Is the Relationship Between MPC and Income?

On average, the marginal propensity to consume (MPC) has an inverse relationship with income, meaning that people with lower incomes will spend a larger share of any extra income and vice versa. This is likely because well-off people already have most of their needs met, and have less to gain from spending the extra income.

The Bottom Line

Marginal propensity to consume (MPC) is a measure of the increased spending associated with an extra dollar of income. Generally, people with lower incomes tend to have a higher MPC because they have more unmet needs than wealthier people.

Reviewed by Michael J Boyle
Fact checked by Timothy Li

In a purely economic sense, inflation refers to a general increase in price levels due to an increase in the quantity of money; the growth of the money stock increases faster than the level of productivity in the economy. The exact nature of price increases is the subject of much economic debate, but the word inflation narrowly refers to a monetary phenomenon in this context.

Using these specific parameters, the word deflation is used to describe productivity increasing faster than the money stock. This leads to a general decrease in prices and the cost of living, which many economists paradoxically interpret to be harmful. The arguments against deflation trace back to John Maynard Keynes’ paradox of thrift. Due to this belief, most central banks pursue a slightly inflationary monetary policy to safeguard against deflation.

Key Takeaways

• Central banks today primarily use inflation targeting in order to keep economic growth steady and prices stable.
• With a 2%–3% inflation target, when prices in an economy deviate, the central bank can enact monetary policy to try and restore that target.
• If inflation heats up, raising interest rates or restricting the money supply are both contractionary monetary policies designed to lower inflation.

Inflation Targeting

Most modern central banks target the rate of inflation in a country as their primary metric for monetary policy. If prices rise faster than their target, central banks tighten monetary policy by increasing interest rates or other hawkish policies. Higher interest rates make borrowing more expensive, curtailing both consumption and investment, both of which rely heavily on credit.

Likewise, if inflation falls and economic output declines, the central bank will lower interest rates and make borrowing cheaper, along with several other possible expansionary policy tools.

As a strategy, inflation targeting views the primary goal of the central bank as maintaining price stability. All of the tools of monetary policy that a central bank has, including open market operations and discount lending, can be employed in a general strategy of inflation targeting. Inflation targeting can be contrasted with strategies of central banks aimed at other measures of economic performance as their primary goals, such as targeting currency exchange rates, the unemployment rate, or the rate of nominal gross domestic product (GDP) growth.

How Central Banks Influence the Money Supply

Contemporary governments and central banks rarely ever print and distribute physical money to influence the money supply, instead relying on other controls such as interest rates for interbank lending. There are several reasons for this, but the two largest are:

1. New financial instruments, electronic account balances, and other changes in the way individuals hold money make basic monetary controls less predictable.
2. History has produced more than a handful of money-printing disasters that have led to hyperinflation and mass recession.

The U.S. Federal Reserve switched from controlling actual monetary aggregates, or the number of bills in circulation, to implementing changes in key interest rates, which has sometimes been called the “price of money.” Interest rate adjustments impact the levels of borrowing, saving, and spending in an economy.

When interest rates rise, for example, savers can earn more on their demand deposit accounts and are more likely to delay present consumption for future consumption. Conversely, it is more expensive to borrow money, which discourages lending. Since lending in a modern fractional reserve banking system actually creates “new” money, discouraging lending slows the rate of monetary growth and inflation. The opposite is true if interest rates are lowered; saving is less attractive, borrowing is cheaper, and spending is likely to increase, etc.

Increasing and Decreasing Demand

In short, central banks manipulate interest rates to either increase or decrease the present demand for goods and services, the levels of economic productivity, the impact of the banking money multiplier, and inflation. However, many of the impacts of monetary policy are delayed and difficult to evaluate. Additionally, economic participants are becoming increasingly sensitive to monetary policy signals and their expectations about the future.

There are some ways in which the Federal Reserve controls the money stock; it participates in what is called open market operations, by which federal banks purchase and sell government bonds. Buying bonds injects new dollars into the economy, while selling bonds drains dollars out of circulation. So-called quantitative easing (QE) measures are extensions of these operations. Additionally, the Fed can change the reserve requirements at other banks, limiting or expanding the impact of money multipliers.

What Is Monetary Policy?

Monetary policy is a set of actions by a nation’s central bank to control the overall money supply and achieve economic growth. Strategies include revising interest rates and changing bank reserve requirements.

In the United States, the Federal Reserve Bank implements monetary policy through a dual mandate to achieve maximum employment while keeping inflation in check.

What Is Inflation?

Inflation is a gradual loss of purchasing power that is reflected in a broad rise in prices for goods and services over time. The inflation rate is calculated as the average price increase of a basket of selected goods and services over one year.

In the U.S., the Federal Reserve targets an annual average inflation rate of 2% by setting a range of its benchmark federal funds rate, which is the interbank rate on overnight deposits.

What Is a Central Bank?

A central bank is a financial institution responsible for forming monetary policy and regulating member banks. It typically has privileged control over the production and distribution of money and credit for a nation or a group of nations.

The U.S. central bank is the Federal Reserve System. Often called the Fed, it was created in 1913 and is arguably the world’s most influential financial institution.

How Does a Central Bank Affect Monetary Policy and Inflation?

Most nations’ central banks target the inflation rate in their respective countries as their primary metric for monetary policy. A central bank affects monetary policy by adjusting the money supply in the economy. A central bank affects inflation by manipulating interest rates through monetary policy, either raising rates to cool the economy when inflation is high or lowering rates to stimulate economic growth when inflation is low.

The Bottom Line

Arguments for monetary policy are that it controls inflation through a target interest rate; is quick and easy to implement; can be undertaken by independent and politically neutral central banks without fear of political repercussions; and can actually boost exports if the nation’s currency is weaker on world markets.

Arguments against monetary policy are that it takes months or even years to have effects on an economy; can lead to a liquidity trap when interest rates are kept very low for prolonged periods of time; affects an entire economy or country when only some sectors or regions might need the stimulus; and creates a risk of hyperinflation.

Economists continue to debate the usefulness of monetary policy, but it remains the most direct tool of central banks to combat or create inflation.

Reviewed by Somer Anderson

Mexico has the 15th largest nominal gross domestic product (GDP) in the world and its economic improvement has been linked primarily to its involvement with the North American Free Trade Agreement (NAFTA) that was established in 1994.

NAFTA is a trade agreement that allows for free trade between the United States, Canada, and Mexico. Most exports are traded among the three countries with no tariffs through NAFTA, eliminating trade barriers for goods and services.

A revised version of NAFTA was negotiated by President Donald Trump during his first term. It’s the United States-Mexico-Canada Agreement (USMCA) and it was entered into enforcement on July 1, 2020.

Key Takeaways

• Income levels and living standards in Mexico have been rising steadily since the 1994 passage of the NAFTA free trade agreement.
• Electronics and auto manufacturing are key industries.
• Poverty has fallen dramatically in Mexico, falling from 36% to 21% over the course of a decade.

Mexico’s Middle Class

The income levels and living standards for the Mexican middle class have been up and down since the NAFTA agreement was signed and then effectively replaced by the USMCA. The number of people earning less than $6.80 per day fell from 36% in 2012 to just over 21% a decade later. Poverty is expected to fall steadily through 2026, as real GDP per capita is expected to increase.

Mexico’s middle class is expected to continue growing, with 3.8 million more households expected to move up to the middle range by 2030.

Policy Changes Helped

Improved financial stability in the country and increased support from the government have been helping income equality substantially in Mexico. The middle class benefited from increased levels of production in electronics and automobiles because NAFTA’s provisions allowed for these goods to be traded tariff-free.

Electronics and automobiles have long been a leading manufacturing focus in the country. Middle-class workers are seeing more job opportunities at better wages with increased production levels.

Electronics and Auto Manufacturing

Both the electronics and automobile industries have grown significantly in Mexico since 1994 with free trade as the catalyst.

Mexico has the sixth-largest electronics industry in the world and is the second-largest exporter of electronics to the U.S. Leading electronic products manufactured in the industry include televisions, display monitors, circuit boards, semiconductors, and computers.

The country is a leading supplier of communications equipment including mobile phones. It’s also one of the world’s top producers of electronic appliances.

Important

Economists expect Mexico to be the world’s fifth-largest economy by 2050.

Mexico is the biggest manufacturer of automobiles in North America. Most of the industry in Mexico is represented by General Motors Company, Ford Motors, and Fiat Chrysler Automobiles. Other leading automobile manufacturers with plants in Mexico include Volkswagen, Nissan, Kia Motors, Mercedes-Benz, and Audi.

More manufacturers are adding or moving their operations to Mexico as the economy and consumer dynamics of the country continue to improve. This trend is expected to continue with the country likely to see an increasing number of manufacturers, specifically in the electronics and automobile industries.

Mexico’s Energy Sector

The energy sector is a highly influential factor in Mexico’s economy. Its land is rich in natural resources that are ripe for commodities mining, exploration, and refining.

Pemex is one of the world’s largest energy companies with a focus on upstream and downstream natural gas and oil operations. It provides a wide range of jobs for the country’s population.

Rising Income Levels

Mexico’s economic growth has been linked simultaneously with the added economic advantages of free trade. The country has benefited from an increased government focus on income equality reform at the same time.

Income levels in Mexico overall have been growing since the mid-1990s but they remain low by U.S. standards.

Future Growth

Economists forecast that Mexico’s economy will grow to the fifth-largest in the world by 2050 primarily as a result of growth in its manufacturing and energy sectors. This growth is expected to add to the rising income levels and purchasing power of Mexico’s middle-class consumers.

Studies show that middle-class Mexican consumers are optimistic about the future economy yet they spend conservatively. More companies in the consumer-packaged goods and retail industries are opening operations there to capitalize on this optimistic yet conservative demand.

AT&T is one example. The telecommunications provider has expanded its high-speed internet service in Mexico with about 21 million subscribers as of 2023.

What Is the Average Daily Wage in Mexico?

The daily minimum wage rose to 278.80 Mexican pesos or $13.76 U.S. effective Jan. 1, 2025.

How Do Tariffs Affect Workers?

Tariffs can affect manufacturing because they must be incorporated into the costs of production. This leaves less money for wages and can result in pay cuts and even the loss of jobs.

What Is Mexico’s Top Export Overall?

Motor vehicles continued to be Mexico’s top export in 2024. In the first half of the year, Mexico exported $29 billion of passenger cars, and another $20.7 billion in vehicle parts and $20.6 billion of trucks. With total exports for that six-month period valued at just under $300 billion, the auto industry accounted for around 24% of the country’s exports.

The Bottom Line

Mexico is the world’s fifteenth-largest economy, thanks in part to free trade arrangements with its neighbors and other trading partners overseas. With a vigorous export economy, the middle class is growing and the level of poverty has fallen dramatically, but it’s not clear how changing trade relationships will affect the country’s development.

Fact checked by Suzanne Kvilhaug
Reviewed by Cierra Murry

Gold ETFs offer exposure to the gold market without requiring investors to buy physical gold, with some equity-based gold ETFs providing dividends from gold-related companies. These dividend-paying ETFs can help mitigate risk by generating cash flow, even during market downturns. Let’s take a look at some gold miner ETFs that pay dividends.

Key Takeaways

• Gold ETFs provide investors with exposure to the gold market without having to purchase physical gold or specific gold stocks.
• Sprott Gold Miners ETF only holds 33 different companies.
• The VanEck Vectors Gold Miners ETF holds 57 different companies with the top 10 holdings representing 64% of the fund.
• The iShares MSCI Global Gold Miners ETF offers biannual distributions.
• The VanEck Vectors Junior Gold Miners ETF tracks the performance of small- and mid-cap companies.

Understanding Gold Miner ETFs

Investors are often attracted to the low costs and ease of trading of exchange-traded funds (ETFs). These funds represent a basket of securities that track an underlying index, giving investors exposure to many different companies with specific characteristics. These companies are commonly related by asset class, company size, or industry.

As such, gold ETFs provide investors with exposure to the gold market without the need to purchase the physical metal or stocks of various gold companies. Only a handful of the available gold ETFs offers the bonus of paying dividends. Dividends are only available with equity-based gold ETFs that invest in the stocks of companies engaged in the gold industry.

Here’s a look at four of the ETF names that track gold and pay dividends. All information is current as of February 2025.

1. Sprott Gold Miners ETF (SGDM)

The Sprott Gold Miners ETF (SGDM) was launched in 2014. The ETF’s goal is to “track the performance of larger-sized gold companies whose stocks are listed on Canadian and major U.S. exchanges”.

The market capitalization of the fund is $287 million. The ETF is strategically designed to mirror the performance of the Solactive Gold Miners Custom Factors Index TR. The benchmark index is also made up of 35 different precious metals companies.

The fund’s operating expenses is 0.52%, though 0.02% of this is waived by the investment advisor of the fund resulting in a net fund fee (total expense ratio) of 0.50%. It has paid a dividend every year since 2018. The ETF last paid a dividend of $0.29 per share to investors on December 19, 2024.

2. VanEck Vectors Gold Miners ETF (GDX)

The VanEck Vectors Gold Miners ETF (GDX), launched by Van Eck in 2006, has approximately $14.1 bllion in net assets under management, making it one of the largest and most widely traded gold ETFs. It trades on the NYSE Arca Exchange.

The ETF’s portfolio is made up of 57 holdings, many of which are some of the world’s largest gold companies. The top 10 holdings comprise 64.65% of the portfolio’s weight. Companies are chosen based on market cap with a minimum of $750 million. Holdings include Newmont, Barrick Gold, and Franco-Nevada. The fund tracks the NYSE Arca Gold Miners Index.

The fund carries an expense ratio of 0.51%, and GDX pays distributions annually. On December 24, 2024, GDX distributed a dividend of $0.4025 per share. The fund has issued a dividend every year since its 2006 inception except for 2008.

Important

Gold ETFs that hold the physical precious metal or that hold gold futures contracts do not offer dividend yields.

3. iShares MSCI Global Gold Miners ETF (RING)

The iShares MSCI Global Gold Miners ETF (RING) was launched in 2012 by BlackRock. With just over $1 billion in net assets, this ETF tracks the MSCI ACWI Select Gold Miners Investable Market Index. As such, it follows the performance of companies in both developed and emerging market economies whose primary revenue source is gold mining.

A total of 38 companies make up its portfolio including notable companies such as Newmont, Barrick Gold, and Agnico Eagle Mines Ltd.

The fund awards semi-annual distributions. On December 20, 2024, the fund distributed $0.216 per share; on June 17, 2024, the fund distributed $0.186 per share.

4. VanEck Vectors Junior Gold Miners ETF (GDXJ)

The VanEck Vectors Junior Gold Miners ETF (GDXJ) was launched by Van Eck in 2009 and has approximately $4.87 billion in net assets. This complementary offering to Van Eck’s larger GDX ETF offers exposure to gold mining firms with lower market cap values.

The fund aims to mirror the Market Vectors Global Junior Gold Miners Index, which was designed to reflect the performance of small- and mid-cap companies that derive the majority of their revenue from gold and silver mining. The fund has 87 holdings.

Major portfolio holdings include Pan-American Silver and Evolution Mining. Unlike the larger funds, the concentration of the portfolio is much more diversified, with the top 10 holdings only making up less than 44% of the portfolio’s assets.

The expense ratio for the fund is 0.52%, and the 12-month yield is 2.12%. On December 24, 2042, GDXJ issued a dividend, distributing $1.1144 per share. The fund has issued a distribution in all but 2 of the 13 years since the fund’s inception.

Do Gold ETFs Pay Dividends?

Some Gold ETFs pay dividends, such as the ones listed in this article. It is important to note dividend yields often change over time. In addition, companies and ETFs may elect to not distribute any dividends for a given distribution period, often a result of poor financial performance.

What ETF Pays the Highest Dividends?

The gold mining ETF that pays the highest dividend in this article is the iShares MSCI Global Gold Miners ETF (RING).

Does Vanguard Have a Gold ETF?

Vanguard does not current offer a gold mining ETF.

Which Gold ETF Is the Safest?

The gold ETF that is the safest will depend on individual risk tolerance and investing style. ETFs are generally safer than individual stocks due to their diversified nature. However, ETFs are also highly centralized within a specific industry or asset class. The risk level across all gold ETFs will be fairly similar.

The Bottom Line

There’s a diverse offering of gold ETFs that range in assets under management size, number of companies held, and fund management expense. These funds also differ in their timing of distributions and dividend yields.

Fact checked by Vikki Velasquez
Reviewed by Samantha Silberstein

As the value of the U.S. dollar rises globally, the U.S. stock indexes tend to rise along with it.

Over the last 20 years, the rise in the value of the U.S. dollar has had a slight positive correlation to the movement of the S&P 500 Index. That is, about 40% of the time, the S&P 500 goes up when the dollar’s value rises.

Clearly, the trend doesn’t hold true all of the time, or not for all stocks. It’s important to determine how and why the stocks you choose can be affected by the rise or fall of the U.S. dollar.

Key Takeaways

• Companies that rely on imports thrive when the U.S. dollar is strong. It lowers their costs.
• Companies that sell their products globally thrive when the dollar is weak. It makes their products more competitive abroad.
• Philip Morris International and Coca-Cola are two companies that can get hit by a strong dollar because they rely on international sales. They sell more when the dollar is weak.

How U.S. Dollar Value Moves Stock Prices

The U.S. dollar, or any currency, can become more valuable in relation to other currencies in two ways. It grows in value when global demand for the currency increases. And, it grows in value when the nation’s central bank reduces the amount of the currency that is available.

It’s practically inevitable that an increase in the U.S. dollar’s value will raise the value of American stock indexes since U.S. dollars are needed to purchase American stocks.

But, the effect of a significant change in the value of the U.S. dollar on a U.S. investor’s portfolio is very much a function of the portfolio’s contents. Your portfolio might be worth less than before, more than before, or about the same as before. It depends on what kinds of stocks are in your portfolio.

U.S. Dollar Stock Correlation Scenarios

The following examples illustrate the potential effects of a declining dollar on an investor’s portfolio, from worst case to best case.

The Worst-Case Scenario

Your portfolio is made up of shares in companies that rely heavily on imported raw materials, energy, or commodities to make money.

Much of the manufacturing sector depends on imported raw materials to create finished goods. When the U.S. dollar declines in value, the purchasing power of the U.S. dollar declines. It will cost manufacturers more to buy their materials, which puts pressure on their profit margins and, ultimately, their bottom lines.

Companies in your portfolio that don’t properly hedge against their reliance on the price of imported goods or the effects of a declining dollar can expose you to foreign exchange risk.

For example, a company that makes baseball bats using imported wood will need to pay more U.S dollars for the wood. The company will have to decide whether it will keep its prices the same and make less money per unit sold or raise its prices and risk losing customers.

The Likely Scenario

Your portfolio is made up of a diverse collection of companies and is not overweight in any one economic sector. You have also diversified internationally and hold stock in companies that operate around the world, selling to many markets.

In this situation, a declining dollar will have both positive and negative effects on your portfolio.

The extent to which the companies you own depend on a high or low U.S. dollar to make money will be a factor in their stock performance, which is why diversification is crucial.

The positive and negative effects of the change in the dollar should balance out.

The Best-Case Scenario

Your portfolio is made up of companies that export U.S. manufactured goods around the world.

Companies that rely substantially on foreign revenue and international exports stand to do very well if the U.S. dollar depreciates in value because they get more U.S. dollars when they convert the foreign cash their products bring in.

A lower dollar also makes high-quality American goods more competitive in international markets. Consumers abroad will choose its products over the domestic competition.

What Companies Do Better When the US Dollar Is Weak?

Philip Morris International and Coca-Cola are cited by Barrons as two examples of stocks that were hit by the strong dollar in early 2025. Both companies rely heavily on international sales for their growth. Their products fare better against local competitors when the dollar is relatively weak.

Why Is the U.S. Dollar Called the World’s Currency?

The U.S. dollar’s unofficial status as the world’s currency stems from its relative stability compared to other currencies. It is considered the world’s reserve currency for the same reason. Some countries have adopted the U.S. dollar as their official domestic currency. Others accept the dollar in addition to their own currencies. Their currency values are pegged to the dollar to keep them stable.

Do I Want a Weak Dollar or a Strong Dollar When I Travel Abroad?

You definitely want a strong dollar when you travel abroad. It means you’ll get more pounds, euros, or yen when you exchange your U.S. dollars.

The Bottom Line

The values of American stocks, especially those that are included in market indexes, tend to increase along with the demand for U.S. dollars. In other words, they have a positive correlation.

One explanation for this relationship is foreign investment in the U.S. markets. As more investors place their money in U.S. equities, they are required to buy U.S. dollars to purchase American stocks, causing the indexes to increase in value.

However, the critical factor is the makeup of your personal portfolio. If your choices are diversified, your money will be protected from the gyrations of the currency exchange.

Learn about capital gains, cost basis, qualified dividends, and more

Reviewed by Julius Mansa
Fact checked by Vikki Velasquez

Many investors have questions about the best way to calculate their taxes on mutual funds. The way your mutual fund is treated for tax purposes has a lot to do with the type of investments within the fund’s portfolio.

In general, most distributions you receive from a mutual fund must be declared as investment income on your yearly taxes. However, the type of distribution received, the duration of the investment holding, and the type of investment are all important factors in determining how much income tax you pay on each dollar of a distribution.

In some cases, distributions are subject to your ordinary income tax rate, which is the highest rate. In other cases, you may be eligible to pay the lower capital gains tax rate. Other distributions may be completely tax-free.

Key Takeaways

• Mutual funds that create a lot of short-term capital gains—and are taxed at ordinary income (not capital gains) rates—can cost you.
• When it comes to distributions, the difference between ordinary income and capital gains is based on how long that fund has held an individual investment within its portfolio.
• If you receive a distribution from a fund that results from the sale of a security the fund held for only six months, that distribution is taxed at your ordinary income tax rate.
• If the fund held the security for several years, however, then those funds are subject to the capital gains tax instead.

Ordinary Income vs. Capital Gains

The difference between ordinary income and capital gains income can make a huge difference to your tax bill. In short, only investment income you derive from investments held for more than a year is considered capital gains.

This concept is pretty straightforward when it comes to investing in individual stocks. The world of mutual funds, however, is a little more complicated.

Mutual funds are investment companies that invest the collective contributions of their thousands of shareholders in numerous securities called portfolios. When it comes to distributions, the difference between ordinary income and capital gains has nothing to do with how long you have owned shares in a mutual fund but rather how long that fund has held an investment within its portfolio.

If you receive a distribution from a fund that results from the sale of a security the fund held for less than a year, that distribution is taxed at your ordinary income tax rate. If the fund held the security for 12 months or more, however, then those funds are subject to the capital gains tax instead.

When a mutual fund distributes long-term capital gains, it reports the gains on Form 1099-DIV, Dividends, and Distributions, and issues the form to you before the annual tax filing date.

Why Is This Important?

The difference between your ordinary income tax rate and your corresponding long-term capital gains tax rate can be quite large. This is why it is important to keep track of which income is subject to the lower rate. Ordinary income is taxed at either 10%, 12%, 22%, 24%, 32%, 35%, or 37% depending on filing status and income.

The capital gains tax rates are 0%, 15%, and 20%, and will depend on your filing status and income. Below are the tax rates and income brackets for capital gains for 2024 and 2025. Note that if you earn above the 15% maximum amount, your capital gains tax will be 20%.

Figuring Your Gains and Losses

If you sell your shares in a mutual fund, any amount of the proceeds that is a return on your original investment is not taxable since you already paid income taxes on those dollars when you earned them. Therefore, it is important to know how to calculate the amount of your distribution attributed to gains rather than investments.

To determine how much of your investment income is gain or loss, you must first know how much you paid for the shares that were liquidated. This is called the basis. Because mutual fund shares are often bought at various times, in various amounts, and at various prices, it is sometimes difficult to determine how much you paid for a given share.

Important

Mutual fund investors can face unexpected tax bills even when a fund’s value declines, as taxable distributions may still occur when the fund manager sells appreciated assets.

Cost Basis and Average Basis

There are two ways the Internal Revenue Service (IRS) allows taxpayers to determine the basis of their investment income: cost basis and average basis.

If you know the price you paid for the shares you sold, then you can use the specific share identification cost basis method. However, if you own many shares that have been purchased at different times, this method may be very time-consuming. Alternatively, you can use the first-in, first-out cost basis method, in which you use the price of the first share purchased as the basis for the first share sold and so forth.

If you cannot determine the price you paid for specific shares, you may choose to use the average basis method, where you can use the aggregate cost of all your shares as the cost basis for each share sold. However, all your mutual fund shares must be identical to employ this method, meaning you cannot use the average basis method to figure your gains if some of your shares are part of a dividend reinvestment plan (DRIP) and some are not.

Like income from the sale of any other investment, if you have owned the mutual fund shares for a year or more, any profit or loss generated by the sale of those shares is taxed as long-term capital gains. Otherwise, it is considered ordinary income.

Dividend Distributions

In addition to distributing income generated by the sale of assets, mutual funds also make dividend distributions when underlying assets pay earnings or interest. Mutual funds are pass-through investments, which means any income they receive must be distributed to shareholders.

This most often occurs when a fund holds dividend-bearing stocks or bonds, which typically pay a regular amount of interest annually, called a coupon.

When a company declares a dividend, it also announces the ex-dividend date and date of record. The date of record is the date on which the company reviews its list of shareholders who will receive the dividend payment. Because there is a time delay when trading stocks, any sale of shares that occurs fewer than three days before the date of record is not registered, and the list of shareholders still includes the name of the selling investor. The date before the date of the record is the ex-dividend date.

How Are Dividend Distributions Taxed?

In general, dividend income is taxed as ordinary income. If your mutual fund buys and sells dividend stocks often, more than likely any dividends you receive are taxed as ordinary income. For example, assume you receive $1,000 in dividend payments from your actively managed fund. If you are in the 24% income tax bracket, you pay $240 at tax time.

However, there are two very important exceptions: qualified dividends and tax-free interest.

Qualified Dividends

Dividend distributions received from your mutual fund may be subject to the capital gains tax if they are considered qualified dividends by the IRS. To be qualified, the dividend must be paid by a stock issued by a U.S. or qualified foreign corporation. Also, your mutual fund must have held the stock for more than 60 days within the 121-day period beginning 60 days before the ex-dividend date.

The ex-dividend date is the date after which the owners of newly purchased stock are ineligible for the dividend payment. If the ex-dividend date is April 12, for example, any investors who purchase stock on or after this date do not receive the impending dividend.

This may sound confusing, but essentially it means the fund must own the stock for either 60 days before the ex-dividend date or a combination of days before and afterward, adding up to at least 60 days. This complicated requirement is meant to discourage investors from purchasing funds with dividend-bearing stocks right before payments and then selling them off again, just to get the dividend. If your fund distributes qualified dividends, these dividends are reported to you on Form 1099-DIV.

Tax-Free Interest

The other way to minimize your income tax bill is to invest in so-called tax-free mutual funds. These funds invest in government and municipal bonds, also called “munis,” that pay tax-free interest. Money market mutual funds, for example, invest primarily in short-term government bonds and are widely considered stable and safe investments.

However, while municipal bonds pay interest that is exempt from federal income tax, they may not be exempt from your state income tax or local income taxes. In some cases, interest paid on bonds issued by governments in your state of residence may be triple-tax-free, meaning the bonds are exempt from all income tax. To avoid being caught off guard by unexpected taxation, verify with your fund which bonds within its portfolio are tax-free and to what degree.

How Are Distributions From Mutual Funds Taxed?

Most mutual fund distributions are considered taxable investment income. The tax rate depends on factors like the holding duration of the investment within the fund and the nature of the distribution, which could be ordinary income, capital gains, or sometimes tax-free.

What’s the Difference Between Ordinary Income and Capital Gains?

Ordinary income typically includes short-term capital gains (from assets held under a year) and is taxed at standard income tax rates. Long-term capital gains, from assets held over a year, are generally taxed at lower rates (0%, 15%, or 20%), which depend on your income bracket.

How Can I Reduce Taxes on Mutual Fund Distributions?

Investing in tax-advantaged accounts, like IRAs, choosing funds that focus on tax-free municipal bonds, or opting for tax-efficient funds can help lower tax burdens. Additionally, qualified dividends and long-term capital gains rates may offer tax savings if distributions are eligible.

The Bottom Line

Calculating the taxes you owe on mutual fund income and distributions can be extremely complex, even for the most seasoned investor. The IRS’s Publication 550, Investment Income and Expenses (Including Capital Gains and Losses) can be some help in informing you about these issues. But unless you own just a handful of shares and keep careful records, you may benefit from consulting a tax professional to ensure you are properly reporting all your investment income.