How Taxes Affect Your Stock Investments
Consider Tax Consequences Before Investing
It is important to keep taxes in mind when investing in the stock market. If you don't consider the tax consequences of your stock investments, you will end up with much less than you planned.
There are two tax environments for investing in stocks: qualified retirement accounts and regular accounts. You will most likely have some investments in both environments.
Qualified Retirement Accounts
Qualified retirement accounts, such as a 401(k) or a Individual Retirement Account, generally allow your money to grow tax-free until withdrawal. Regular qualified accounts let you invest money before you pay income taxes. This lowers your current tax bill.
However, when you withdraw the money in retirement, you pay regular income taxes on your contributions and any earnings.
A Roth retirement account allows you to invest after-tax dollars. It does not lower your current tax bill. However you can withdraw contributions and earnings tax-free during retirement.
If you believe you will be in a lower tax bracket during retirement, you are better off with a regular retirement account. If you believe you will be in a high tax bracket during retirement, you should consider a Roth account.
There are certain restrictions on regular and Roth retirement accounts, so consult your tax advisor before deciding on the best option for you.
Unqualified Stock Investment
Unqualified stock investment accounts have two basic taxes to consider. If your stock pays dividends, you must pay income taxes on the payments. Generally, the tax on dividends is 15%. However, that is always subject to change.
The other tax consideration involves selling the stock for a profit or loss. If you hold the stock for more than one year, any gain is taxed at long-term capital gains rates. This rate is also 15% and is also subject to change.
If you sell a stock for a profit but have owned the stock for less than one year, you will pay regular income taxes on the gain. Depending on your tax bracket, this could be significantly higher than 15%. As always, check with your tax advisor.
What if you sell for a loss? In many cases, you can claim a long or short term capital loss. These losses can often be used to offset capital gains.
It is important to consider the tax consequences of your stock investments. Generally, the more you can put into a qualified retirement account, the better it is from a tax point of view.
However, your stock investments are only one piece of your tax situation. A qualified tax advisor can help you decide the best strategy.