You likely have investments in an employer-provided retirement plan or in your own individual retirement account (IRA). You may also own one or more taxable investment accounts, such as a non-retirement mutual fund account, or shares of individual companies held in a brokerage account. Understanding how your investment earnings in each type of account will be taxed is important from a tax-planning perspective. Here is a brief overview.
Common types of tax-deferred accounts include: an employer’s qualified retirement plan, such as 401(a) or 401(k) plans; a 457(b) supplemental savings program; and a traditional IRA. You won’t have to pay taxes on capital gains, dividends or interest earned on investments held in a tax-deferred account while the earnings remain in your account. But, when you start withdrawing money from these accounts at retirement, contributions to your retirement plan and any earnings on your investments will be taxed at ordinary income tax rates (except to the extent of any after-tax contributions).
Roth IRAs, Roth 457(b) and Roth 401(k) accounts have unique tax aspects. For both, contributions are made with after-tax dollars and investment earnings are tax-deferred, but any distributions will be income tax free if all requirements are met. Generally, you must maintain a Roth account for five tax years and make withdrawals after age 59½ (or meet certain other limited requirements) to avoid paying income tax on investment earnings.
Taxable Investment Accounts
With taxable investment accounts, such as a brokerage account or non-retirement mutual fund account, you will have to pay income tax on any earnings (also known as gains) that you make. Therefore it is important to understand the term “basis” when it comes to calculating capital gains and losses on securities you have in a taxable account. Your basis in a security is the price you paid for the shares of stock or a mutual fund, adjusted for any reinvested dividends or capital gains distributions as well as for any cost of the purchase. Note: Reinvested dividends and capital gains distributions are added to basis because they are taxed in the year of distribution. To calculate gain or loss, you compare your basis in the securities to the amount realized on the sale of the securities.
For federal tax purposes, long-term capital gains are taxed at lower rates than ordinary income, such as interest on a savings account or a taxable bond.
|2021 Capital Gains Rate||Single
|Married Filing Jointly||Head of
|Married Filing Separately|
|0%||Up to $40,400||Up to $80,800||Up to $54,100||Up to $40,400|
|20%||Over $445,850||Over $501,600||Over $473,750||Over $250,800|
For a capital gain to qualify as a long-term capital gain, you must generally retain your securities for more than one year before selling. If you sell any securities that have capital gains after holding them for one year or less, your gain will generally be taxed at regular income tax rates. Once certain tax law conditions are met, your dividends can qualify for the long-term capital gains rates.
Tax issues can be confusing for many investors. Consult a tax or financial professional if you have questions or would like help with planning the sale of your investments.