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My friends, I have good news and I have bad news.<\/p>\n
The good news is that investment taxes are a lot simpler and easier than you may expect.<\/p>\n
The bad news is that you\u2019re about to hate your earned income by comparison. <\/p>\n
T\u2019was the tax season of 2019 (for 2018 taxes) and yours truly was an investing spring chicken. <\/p>\n
I had put a few thousand dollars in a few different accounts, and I felt positively #adult about it. I was talking on the phone with my dad while strolling the aisles of Kroger for that week\u2019s rations of potato chips and Oreos, explaining how I was so<\/em> ahead of the game and had already filed my tax return. <\/p>\n \u201cBut have you gotten your 1099s yet?\u201d he asked. <\/p>\n \u201cWhat?\u201d I replied, already scoffing that my dad clearly knew nothing of the tax wizard I was.<\/p>\n \u201cYour 1099s. From your investment accounts,\u201d he replied. Panic ensued.<\/p>\n \u201cI have to pay taxes on those?\u201d I asked, incredulous. Why didn\u2019t anyone tell me? <\/p>\n \u2026and that\u2019s how I found out you have to pay taxes on your investment accounts! Surprise!<\/p>\n Luckily, I had so little that it wasn\u2019t too harsh of a course correction, but the more you sock away in your investment accounts, the more crucial it becomes that you\u2019re on top of reporting it.<\/p>\n While your traditional 401(k) and IRA are great tax deduction vehicles (and you should definitely fill out that portion of the tax software if it\u2019s not automatically done for you), you aren\u2019t taxed on them in the same way you are in taxable accounts. After all, that\u2019s kinda the point \u2013 so don\u2019t worry too much about growth in those accounts.<\/p>\n Same with your Roth accounts \u2013 because you paid the taxes on the income upfront then invested it, you generally won\u2019t have to pay taxes on them again in retirement.<\/p>\n This is where the term \u201ctaxable\u201d investing gets its name \u2013 it\u2019s just everything that isn\u2019t a tax-advantaged account.<\/p>\n If you have an investing goal or have any number of other countless \u201cindividual investing\u201d or \u201cjoint investing\u201d accounts over the last 12 months, it\u2019s likely that you experienced some<\/em> gain. <\/p>\n For example, if you invested $1,000 in January of 2020 and today you have $1,200, that $200 difference is your gain. Usually, for most index fund investors, their gains will be composed of two things: <\/p>\n Capital gains (the asset went up in value; in other words, it\u2019s worth more now than when you bought it)<\/p>\n For example, you buy a share of a company that\u2019s worth $20 per share when you buy it, and a year later it\u2019s worth $25 per share \u2013 that $5 difference is a capital gain<\/p>\n<\/li>\n<\/ul>\n<\/li>\n Dividends (think about this like a token of appreciation from a company; the company is essentially distributing its profits to shareholders, and some companies offer higher \u201cdividend yields\u201d than others, which essentially is the measure of what percentage of your share you\u2019ll receive as a dividend)<\/p>\n For example, if you buy a $20 share of a company that pays you a dividend of $1 per share, its dividend yield is 5%. <\/p>\n<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n Now, if you do nothing with that money and allow it to ride<\/strong>, you may not have to pay any taxes on the capital gains. <\/p>\n You only pay taxes on capital gains when you \u201crealize\u201d them, which essentially means selling the share at a gain (using the example above, if you sold your share that you bought for $20 at $25, you\u2019re profiting that $5 gain and the IRS is going to wrap its grubby little paws around it). <\/p>\n (Now, if you sell at a loss<\/em>, you can claim that too and you may be able to use the loss to offset some taxable income \u2013 but for the purposes of today\u2019s post, we\u2019re not going to get into the nitty gritty there.)<\/p>\n So obviously you\u2019re going to sell eventually \u2013 whether that\u2019s in the short-term (unexpectedly) or in the long-term 15 years from now when you\u2019re kissing Corporate America goodbye and signing up for tango lessons. <\/p>\n Here are two ways the capital gains may be taxed, depending on how long you held it:<\/p>\n If you sell in less than<\/em> 365 days (one year): You\u2019ll pay your earned income marginal tax rate (in other words, your tax bracket rate) on the gain<\/a>. This is definitely sub-optimal and should be avoided at all costs if possible.<\/p>\n For example, if we had sold our $20 share at $25 after, say, six months, and we\u2019re in the 24% tax bracket, we\u2019d pay $1.20 in taxes on that gain. Gross. Of course, it\u2019s still better than nothing \u2013 you\u2019re still getting ahead \u2013 but you\u2019re less ahead than you could be if you had waited or sold older shares first. <\/p>\n<\/li>\n<\/ul>\n<\/li>\n If you sell after<\/em> 365 days (one year): You\u2019ll pay the capital gains and dividends tax rate<\/strong> on the income<\/a>. Everyone is familiar with the regular tax brackets, and most of us are in the 22-24% range. The capital gains and dividends tax brackets are a lot easier to navigate and can be way<\/em> more forgiving (that\u2019s the good news about investing!). <\/p>\n If you (as a single person) have $40,400 or less in declared income, you won\u2019t pay any taxes on your long-term capital gains. That\u2019s right. 0%.<\/p>\n<\/li>\n If you have between $40,401 and $445,850 in income (yep, that\u2019s not a typo), you\u2019ll pay 15%. <\/p>\n<\/li>\n And if you have more than $445,851 in income, you\u2019ll pay 20%. <\/p>\n<\/li>\n<\/ul>\n And that\u2019s it. A little less convoluted than earned income taxation, huh? <\/p>\n<\/li>\n<\/ul>\n So if you\u2019re cruising with your investment accounts and you\u2019re in it for the long-term, you may be like, Cool, I\u2019m good \u2013 I haven\u2019t sold anything<\/em>.<\/p>\n But those dividends will be taxed annually whether you reinvest them or not (that is, keep them in the account and set them to \u201creinvest\u201d or withdraw them). You pay taxes regardless. <\/p>\n Normally, there are two types of dividends:<\/p>\n Ordinary dividends are taxed like ordinary income<\/a> (in other words, you\u2019ll pay your marginal tax rate on these bad boys).<\/p>\n<\/li>\n Qualified dividends that meet certain requirements are taxed similarly to capital gains<\/a>, using the more forgiving brackets described above.<\/p>\n<\/li>\n<\/ul>\n Well, would you turn down a raise because it means you\u2019re going to pay more in taxes?<\/p>\n No, probably not. <\/p>\n Of course, the discussion above is a pretty decent support case for maximizing your 401(k) and Roth IRA contributions first \u2013 since the ongoing tax situation on those bad boys is pretty simple (and by simple, I mean you often don\u2019t have to do or pay anything each year until you start using<\/em> the 401(k) \u2013 but you can buy and sell in those accounts with reckless abandon, though I don\u2019t advise it). <\/p>\n I have a slew of articles about why the 401(k) and Roth IRA should be treated like the Gordo and Miranda to your Lizzie, and I\u2019ll link them below \u2013 but if you\u2019re ready to begin taxable investing (read: you\u2019re already contributing the maximum amounts allowed to your retirement accounts), I certainly wouldn\u2019t let the taxes scare you away. <\/p>\n If you owe taxes on investment gains, that means you have<\/em> investment gains \u2013 and that\u2019s a beautiful thing. Of course, there are ways to help minimize the pain \u2013 first and foremost:<\/p>\n Try your best not to sell assets that you\u2019ve had for less than a year. <\/p>\n<\/blockquote>\n That\u2019s one great way to help minimize your tax liability on growth, since once you cross the one-year mark you\u2019ll be dropped down into the sweet, sweet capital gains tax brackets. <\/p>\n It\u2019s pretty simple: Most firms will send you something called a 1099-DIV<\/strong> at the end of January. This will list your capital gains, ordinary dividends, qualified dividends, etc. \u2013 and that\u2019s what you\u2019ll upload to your tax software of choice or give to a licensed tax advisor.<\/p>\n To give you a sense for scale, on an account that closed out 2020 with almost $60,000 invested, I had only $576 in ordinary dividends and $388 in qualified dividends. <\/p>\n Some quick math: <\/p>\n $576 * 24% (ordinary income tax rate) = $138<\/p>\n $388 * 15% (qualified dividends\/capital gains tax rate) = $58<\/p>\n I\u2019ll pay about $200 in taxes this year on an investment account that grew by approximately $6,500. Would I forego the investment opportunity because I don\u2019t want to pay $200 in taxes? Of course not. <\/p>\n Paid non-client of Betterment. Views may not be representative, see more reviews at the <\/em>App Store <\/em><\/span><\/a>and <\/em>Google Play Store<\/em><\/span><\/a>. <\/em>Learn more<\/em><\/span><\/a> about this relationship. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.<\/em><\/p>\n Betterment offers investment portfolios and automated tools that are designed with tax efficiency in mind. In other words, you don\u2019t have to worry about accidentally selling something too soon without Betterment warning you that whatever you\u2019re about to do could have a tax impact.<\/p>\n If you\u2019re on the fence about investing, you may have perfectly valid reasons to feel gun-shy \u2013 but taxes shouldn\u2019t be one of them. <\/p>\n<\/div>\n My friends, I have good news and I have bad news. The good news is that investment taxes are a lot simpler and easier than you may expect. The bad news is that you\u2019re about to hate your earned income by comparison. To begin, gather \u2018round for a story T\u2019was the tax season of 2019 […]<\/p>\n","protected":false},"author":178814,"featured_media":2463,"comment_status":"closed","ping_status":"open","sticky":false,"template":"si-template-single-post-taxable-investing.php","format":"standard","meta":{"footnotes":""},"categories":[35],"tags":[44],"class_list":["post-240","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing-and-taxes","tag-taxable-investing"],"yoast_head":"\nYou don\u2019t have to worry about your 401(k)s and IRAs<\/h2>\n
What does this look like in practice?<\/h2>\n
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How capital gains are taxed, when you finally sell<\/h3>\n
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But let\u2019s circle back to dividends<\/h3>\n
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Should taxes scare you from investing?<\/h2>\n
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What does this look like in practice?<\/h3>\n
Firms like Betterment work to help make taxes really simple<\/h2>\n
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\n Get started with Betterment
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