If you purchased back-end load mutual funds (also known as the deferred sales charge or DSC), you are entitled to cash in a portion of the fund every year without triggering the sales charge. However, if you don’t use it many mutual fund companies will not let you carry it over.
If you want to take advantage of these free units, you may be able to transfer your units to the front-end load or other series of the same fund without any immediate tax consequences.
Back-End Load Funds
The load charge of a mutual fund simply refers to when you pay the commission. Front load funds charge you a commission up front, when you buy the fund. This effectively reduces amount you invest.
Back-end load funds charge you a commission when you sell out of your fund. The commission is generally reduced every year depending on how long you hold the fund. Many mutual fund deferred sales charges are eliminated after five or seven years.
Free Units
Most back-end load mutual funds reduce the sales charge over time and the DSC fee is eliminated after the holding period is up. However, if you need access to your funds before the holding period is up you will have to pay the DSC fee, unless you have any free units.
A free unit refers to the mutual fund allowing you to redeem up to 10% of the value of the fund annually without paying the commission. Now this is a use it or loose it scenario: If you don’t use your 10% this year, you don’t get to carry it forward to the next year.
Tax Consequences
If you actually redeem your units for cash (or buy another mutual fund), you will have a capital gain or loss. However, if you request that the free units be moved to the front-end or other version of the same mutual fund, you can avoid an immediate the tax-event. Therefore, you can continue to hold a different version of the same mutual fund without paying any tax until you actually sell out of the fund.
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{ 2 comments… read them below or add one }
My investment advisor normally charges me a commission when making a purchase of a DSC mutual fund on my account. He does not charge a commisson when purchasing a front end loaded fund on my account, presumably because he gets a commission from the mutual fund company.
Is that typical for most advisors?
Hello Brad,
DSC Funds pay the advisor up front and you pay no commission up front.
Front load funds charge you a commission up front.
This is normal.