SIE practice questionmediumETFs — Tax Efficiency
ETFs are generally more tax-efficient than mutual funds because:
- AThe in-kind creation/redemption process minimizes capital gains distributions✓ Correct answer
- BETF dividends are tax-free
- CETF shareholders never pay capital gains taxes
- DETFs are classified as tax-exempt organizations
Explanation
Why A — The in-kind creation/redemption process minimizes capital gains distributions
The in-kind creation/redemption mechanism allows ETFs to handle redemptions without selling securities for cash, avoiding taxable capital gains events within the fund. Mutual funds must sell securities to meet redemptions, potentially generating capital gains distributed to all shareholders. Note: ETF investors still owe capital gains taxes when they personally sell shares at a profit. Dividends are also still taxable.
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