The Benefits of Taxable Accounts and How to Manage Them

Choosing between tax-free or taxable accounts? It sounds like it should be an obvious choice, doesn’t it?

It’s not.

Let’s look a bit closer at taxable accounts. In a previous post, we introduced the benefits of using taxable accounts to maximise your retirements savings. Yes, it can look like complicated stuff but we’re here to break things down for you and help you make the most of your money, even if it means paying tax on your savings.

Let’s recap. What are taxable accounts? Taxable accounts are, in many ways, just like a normal savings account. You can put money in when you want to, you can take money out when you want to; there are fewer rules and restrictions on a taxable account than there are on IRAs and other tax-free accounts.

Interest and Dividends from Taxable Accounts

You’ll be investing in stocks, bonds and mutual funds meaning that your money will be working a bit harder for you, hopefully earning you interest, dividends and capital gains.

Any interest earned on savings is going to count as income and you’ll pay tax accordingly; just add the amount of interest earned onto any other income, and keep an eye on the tax brackets to see which tax rate you’ll be paying.

Dividends, either ordinary or qualified dividends, act in pretty much the same way. All dividend income must be reported – even if they’re reinvested – and tax will be due at a rate dictated by your tax bracket. Ordinary dividends are taxed, like interest, as ordinary income and qualified dividends behave more like capital gains.

Capital Gains from Taxable Accounts

Money invested in taxable accounts are generally put into stocks, bonds or mutual funds and capital gains are the profits made when these assets are sold at a higher value than they were bought for. These profits are – you guessed it – taxable income.

Now we might need to pay a little bit more attention, because here’s where things can get difficult – but also clever.

Firstly, income from capital gains is not calculated like regular income. They’re divided into short-term capital gains and long-term capital gains, depending on how long you’ve owned the asset that has made you the profit – short-term if you’ve owned it for less than a year, long-term if you’ve owned it for longer than a year.

Short-term capital gains are taxed at your normal tax rate, while long-term capital gains are taxed at a rate of 0%, 15% or 20%, depending on your other taxable income.

Capital Loss from Taxable Accounts

Of course, the flipside of capital gains is that the value of your stock or bonds can also go down, making the asset less valuable than when you bought it. If you sell it at this point, you’ve effectively lost money; this is a capital loss, and for tax purposes this loss can be deducted from your income.

Now, you can choose when you sell your assets to realize gains or losses so you can have a little say on exactly when those taxes will be due, and here’s when a diverse investment portfolio can really show its strength. You can offset the capital losses against the gains, and this is known as tax-loss harvesting.

You’ll only ever pay taxes on your net gains – your profits minus your losses. If you know you’re going to realize some gains, you can sell investments that have lost value since you acquired them and this will have the knock-on effect of lowering your taxes.

Basis, Performance and Their Impact on Your Tax Bill

At this point, it’s important to also understand the concept of basis, because this too is going to have some implications on your income tax. Basis refers to the total amount that an asset has cost you, not its increase in value. Say that you buy stock for $100,000 and after some time, dividends of $10,000 are paid. You decide to reinvest all of that; the value of that fund is now $110,000. That fund has now cost you $110,000 – the basis has increased.

Another investor has bought stock for $100,000 and a rise in the market has increased the value of that stock by $10,000; now that fund is also worth $110,000 but at no extra expense to the investor. This can be seen as performance – an as-yet unrealized capital gain that may potentially need to be used to calculate income tax.

Keeping Track of Taxable Accounts

Keeping track of taxable accounts can be tricky – especially if you have a diverse investment portfolio – but we love to work closely with our clients on this.

Our software helps you track all the investments you own so together we can keep a close eye on what’s going on.

Contact us today so we can show you how with careful monitoring and management of each dividend, each gain and each loss, we can help you make the right decisions and make the most out of your money.

investing for retirement ebook ipad - McClain Lovejoy
investing for retirement ebook ipad - McClain Lovejoy
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