Under normal circumstances (in a “taxable account”), you pay taxes at two different events:
A buy and hold investor of broad-based market funds (which you should
see Bogleheads’ discussion on asset
allocation) is generally going to be most concerned with dividend taxation.
Generally speaking, dividends are taxed at long-term cap
Selling-Stock section below).
This tax can be quite large:
- Given the information on the left, your dividends will be taxed at a ----% rate.
- The highest tax rate is in California, where a taxpayer in the highest bracket (>$1M/year in
pays 36.6% taxes on their dividends (20% federal,
investment tax, 13.3% state).
Historically, the stock market has a 2% dividend yield (meaning each year, you receive 2% of your
portfolio value in dividends). Assuming you reinvest these dividends, a ~30% tax is akin to paying a
“fee” of ----%/year. (2% * ----%). That small number adds up over time:
- $10,000 growing at 8%/year will be $100,000 in 30 years
- $10,000 growing at ----%/year (6% less a ----% tax fee) will be $---- in 30
years, a $---- reduction!
Stock selling taxation
When you sell stock (including mutual funds, exchange-traded funds (ETFs)), etc. at a price higher
what you purchased it at, you pay “capital gains tax” on the difference (the “capital gain”) between
sales price and purchase price (“basis”).
If you’ve held the stock for a year, you pay long-term cap gain tax rates (less than a year, you pay
higher, “ordinary” rates) on the gain. As discussed in the dividends section, your tax rate is
In practice, we don’t discuss the logistics of selling stock much as:
- It’s rarely necessary if you buy and hold index funds while you are working.
- If you do sell, you’ll be retired and in a lower tax bracket than when you were working (perhaps
- If you donate stock, you don’t pay these taxes.
- If you die, your heirs never have to pay the capital gains taxes (“basis step up”).
- You pay taxes on the aggregate capital gains less losses at the end of a tax year. The fact that
can effectively reduce gains by selling “losers” leads to a practice we’ll discuss in other
called tax-loss harvesting.
- Capital losses don’t offset dividends (there’s no way to escape taxes on dividends).
In both tax-deferred (IRAs, 401(k), etc.) and tax-free (Roth IRAs, Roth 401ks, 529, HSA, etc.)
accounts, all investment transactions are tax-free. So:
- All dividends are tax-free
- No capital gains on sales
These tax-advantaged accounts are incredibly valuable because of the avoidance of these (especially
taxes. See how much a Roth is worth to you!