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  • Reducing Tax Burden on Investment

    I am thoroughly confused on how earnings/interests on a taxable account are earned compared to a retirement account when one uses it to save for long term. I put some money into Betterment brokerage account after maxing our my other investment accounts. After a month of leaving it there I was pleased to see it up almost 8%. Then I was wondering if there were tax implications for this even if I don’t withdraw the funds at the end of the year. Can someone please lend insight since I’ve heard conflicting input another this (saying I would still be taxed at my marginal tax rate for any interest or dividends earned)? Also that I might consider putting it in an investment trust to minimize tax burden. Please help me sort this out!

  • #2
    There may be some capital gains associated with rebalancing your portfolio (done automatically by Betterment) but these should mostly be taxed at your long-term capital gains rate if held for > 1 year (15-20% for most physicians).  Dividends should be taxed at similar rates.  Only if short-term (< 1 year) will gains or dividends be taxed at your marginal rate.

    I have a small portfolio with Betterment and most of the gains from last year were offset with losses.  I'll be interested to see this year's 1099 since gains should outpace losses.

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    • #3




      I am thoroughly confused on how earnings/interests on a taxable account are earned compared to a retirement account when one uses it to save for long term. I put some money into Betteement brokerage account after maxing our my other investment accounts. After a month of leaving it there I was pleased to see it up almost 8%. Then I was wondering if there were tax implications for this even if I don’t withdraw the funds at the end of the year. Can someone please lend insight since I’ve heard conflicting input another this (saying I would still be taxed at my marginal tax rate for any interest or dividends earned)? Also that I might consider putting it in an investment trust to minimize tax burden. Please help me sorr this out!
      Click to expand...


      Interest earned (on bonds, for example) will hit your 1040 on line 8a.  This will be taxed at your marginal rate.  This is why many advocate for putting bonds in a tax-advantaged account where it doesn't get taxed until there is a withdrawal.  Some bonds or bond funds don't have interest taxed at the federal level (muni bonds, for example) but may get taxed at the state level depending on what muni bond you bought.  This interest will go in line 8b on your 1040.

      Regarding equity holdings in your taxable account this completely depends on whether you invested in individual stocks or mutual funds, whether they have dividends, and when you decide to sell.  Individual stocks that don't produce dividends and that you don't decide to sell won't be taxed.  When you sell, you will be taxed based on two things - the length of your holding the stock, and whether there is a gain/loss.  A loss can be used to offset gains on other sales, or taxable income (will hit line 13 on your 1040 and require a schedule D) up to $3,000 yearly (excess losses can be carried forward).  If you sell for a net gain, your gain will be taxed at your marginal rate when holding for one year or less, and will be taxed at long-term capital gains rates when holding for longer (this will vary based on taxable income and MAGI, could be 0-23.8%).  There are two rates embedded in this - the long term capital gains rate (0, 15 or 20%, based on taxable income) and the net investment tax (3.8% based on MAGI, >$250K for MFJ).  Dividends from those stocks will be taxed based on whether they are qualified or not.  This gets a little complicated depending on the kind of stock you bought and holding period, but generally speaking a run-of-the-mill stock that you buy and hold will most likely produce qualified dividends.  These get taxed at the long-term rate described before (with net investment tax applied as well).  Ordinary dividends, not qualified, will be taxed at your marginal tax rate, as they are included in taxable income and not treated separately on the qualified dividends and capital gains tax worksheet (see the 1040 instructions to see this worksheet - I think it will help you understand this a bit better).

      Mutual funds are similar to stocks but involve the wrinkle of fund turnover (buying a selling the fund manager did either to buy/sell into new stocks or because other people were buying/selling).  The more buying/selling the more turnover and the more you'll get hit with capital gains/losses, the taxation of which depends on the holding period described above with stocks.  Dividend distributions from mutual funds (from the underlying stocks) are treated the same as stock dividends, generally speaking.

      This is why the optimal strategy from a tax efficiency standpoint is typically to buy-and-hold, or to buy mutual funds that have low turnover, and to put interest-producing investments in tax-deferred accounts since they will typically be taxed at your marginal rate.  Given all the exceptions and various moving parts there are no absolutes here.  You could be a low-income earner, invested in low turnover, dividend producing funds, and pay zero tax - effectively making this like a Roth, assuming you sell and keep yourself in a 0% LT capital gains/dividend tax bracket.  Point is, you need to look to your own individual situation to see what is optimal.  Clear as mud?

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      • #4

        1. Income (dividends, interest) and growth (capital gains) in a retirement account for which you have received a tax deduction at the time of contribution (or have not been taxed at contribution, such as for employer contributions) are not taxed until you take $ out of the account. All "distributions" (money taken out) are considered income taxed at your top marginal rate. There is no special treatment for dividends or capital gains.

          • Of course, this does not apply to Roth contributions, since you did not get a deduction at the point of contribution.



        2. Income and growth in a taxable account (i.e. in your name and not titled to a retirement account) are taxed "live" at the time of the transaction.

          • When dividends are paid on your investments, they are taxed to whoever is listed as the account owner. If they are "qualified" they are taxed at special rates. If they are not, they are taxed at your top marginal rate.

          • When capital gains are paid to you on mutual funds as a result of selling within the fund (by the fund managers), they are taxed to the account owner. The long-term gains are taxed at special rates and the short-term gains are taxed at your top marginal rate. This information is reported to you on form 1099 at the end of each year.

          • When you sell investments in a personal account, you are subject to the same treatment as for the above. The difference is that you have control over when you want to sell and can control "long-term" versus "short-term" capital gains. This applies to shares of mutual funds, individual stocks, and other investments such as the sale of shares of a limited partnership.




        There are other, more complicated, situations, but this covers the basics. Please let me know if you have any follow-up questions.
        Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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        • #5
          Take the time to read Phil DeMuth's "The Overtaxed Investor" for the big picture. Put bonds into tax deferred to minimize RMDs. Stocks into taxable accounts to snag capital gains rates.

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