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Vanguard Group and its executives created large tax bills for some investors in their due date funds, totaling hundreds of millions of dollars, according to the lawsuit filed on Monday.
The lawsuit, filed in federal court in Pennsylvania by three investors, alleges that an investment manager instigated a sell-off of his TDFs in an “elephant stampede.”
The sell-off ultimately resulted in “huge” tax bills in 2021 for people who held funds in a taxable brokerage account rather than a tax-favored one like a 401(k) plan or individual retirement account, the lawsuit alleges.
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Thus, Vanguard, as well as the fund’s managers and trustees, violated their legal obligations to investors, the lawsuit says.
The plaintiffs – Valerie M. Verdue, Katherine Day and Anthony Pollock – are seeking compensation for alleged damages on behalf of a class of investors in a similar position across the country.
A spokesman for Vanguard declined to comment on the lawsuit.
Fees and location of assets
The substance of the lawsuit relates to two types of due date mutual funds that Vanguard makes available to retail and 401(k) investors.
TDFs are funds that become more conservative over time as investors approach their expected retirement age.
The lawsuit also concerns “location of assets,” a financial planning principle that says certain types of investments are best kept in tax-advantaged accounts to avoid unexpected tax bills.
The two Vanguard Target pension funds had the same investment strategy. But investors needed at least $100 million to access the cheapest version of mutual funds before December 2020. That same month, Vanguard lowered the threshold to $5 million, leading to a massive churn away from the more expensive version.
According to the lawsuit, this leak of money forced Vanguard to sell up to 15% of its assets in more expensive retail funds. The suit alleges that Vanguard needed to sell the fund’s assets in order to raise cash to buy back shares for investors.
Typically, when a mutual fund sells its assets for a profit, it results in the distribution of capital gains to the fund’s shareholders. Investors who own funds in taxable accounts pay taxes on these capital gains; conversely, those who own them under 401(k) plans, individual retirement accounts, and other tax-advantaged accounts can reinvest profits without tax bills.
According to the lawsuit, in this case, investors in more expensive funds received payouts at least 40 times more than in previous years. According to them, the plaintiffs incurred tax payments for 2021 of approximately $9,000 to $36,000.