How your investing and retirement accounts are taxed

Discovering ways to make my hard-earned money work harder for me brings me immense satisfaction and I’m passionate about helping people do the same.

Which is why I encourage everyone to learn how to invest in multiple retirement accounts because you are building wealth over time through investing AND receiving significant tax savings now or in retirement.

Retirement accounts aren’t the only place to invest, and for many people a taxable brokerage account can make a ton of sense. It’s super flexible and you can pull your invested money out anytime you want.

That said, I strongly recommend you plan to invest for the long haul in a taxable brokerage account because of market fluctuations and short-term capital gains tax if you sell investments you’ve owned less than a year (more on this below.)

In this article we will cover:

Retirement accounts
Taxable brokerage account taxes
Tax loss harvesting
What you should expect during tax season

Retirement Accounts

1. If you contribute to retirement accounts like IRA’s or 401(k)’s, as long as you’re not retired and using your retirement funds, you don’t need to be concerned about taxes.

These investment vehicles offer tax advantages where you’re not taxed on the growth in those accounts every year like you are with taxable accounts. This means that you can buy, sell, and earn dividends and interest inside these accounts without worrying about paying taxes annually on any gains.

Essentially, if you only invest within retirement accounts, you don’t need to worry about investment taxes.

2. How long do you have to contribute to an IRA?

You can contribute to a Roth IRA for 2022, up until you file your taxes in 2023. You do not need to make your contribution to an IRA during the calendar year for it to count towards the year in which you are filing taxes for.

If you have a business or made side hustle income, you still have time to contribute to SEP IRA, which is a retirement account that will reduce your taxable business or side hustle income.

Taxable Brokerage Accounts

If you have taxable brokerage accounts (basically any investing account that’s not a retirement account), it is, well, taxable.

There are two main types of taxes.

Capital gains refer to the increase in an asset’s value over time. For example if you bought an investment for $5 and sold it at $10, you would have a capital gain of $5 and would be obligated to pay taxes on that gain.
Dividends are payments made by the company to shareholders for investing in their company. Some companies offer higher dividend yields than others. For instance, if you invest $20 in a company with a 5% dividend yield, you’ll earn $1 per share.

Capital gains and dividends are taxed differently from earned income. If you’re investing regularly in your account and not selling anything, you won’t have to pay taxes on capital gains.

You only pay taxes on capital gains when you sell an asset at a profit. However, selling an asset triggers a tax event, even if you’re reinvesting the money within the confines of the brokerage account and not withdrawing any money.

How are capital gains calculated?

The tax rate on your capital gains is determined by how long you held the investment and your total income from all sources (this includes your salary, side hustles, and investment income.)

If you sell your investment after holding it for fewer than one year, your marginal tax rate applies to the gain. This is not ideal because it will likely be higher than the capital gains tax rate.

If you hold your investment for more than one year, you pay the capital gains tax rate on the gain, which is typically far more favorable than your marginal tax rate.

For example, if you’re single and have a total income of $41,675 or less in 2022, you don’t pay taxes on your long-term capital gains. For married couples filing jointly, the 0% bracket applies to total incomes of up to $83,350.

If your income is between $41,676 and $459,750 (yes, that’s correct) in 2022, you’ll pay 15%. For married couples filing jointly, the range is $83,351 to $517,200. If your income is $459,751 or more, you’ll pay 20%, and for married couples, the total income above $517,201 is taxed at 20%.

Most people fall into the 15% capital gains tax rate.

How are dividends taxed?

Whether you reinvest them or withdraw them, your dividends are taxed annually, as they are considered income for the year you earned them. There are two types of dividends: ordinary and qualified.

Ordinary dividends are taxed at your regular tax rate, whereas qualified dividends, which meet certain requirements, are taxed similarly to capital gains at more forgiving brackets. Your 1099-DIV statement from your brokerage firm will clearly outline both types of dividends.

If you reinvest your dividends, you’re technically being taxed on income that you never withdrew as cash. This is different from how you’re taxed on the income you receive on your paycheck, as you’ll need money from another source to pay the tax bill associated with your dividends.

Tax Loss Harvesting

If your stocks have lost value, you can use tax loss harvesting to offset gains from other investments. Here’s how it works: You sell a holding that has decreased in value and recognize a capital loss. You can use this loss to offset gains from other investments.

The key is to reinvest your remaining money in something similar but not “substantially identical”. You want to avoid a wash sale, which is when you sell an investment at a loss and buy a substantially identical stock within 30 days before or after that sale.

You can typically deduct up to $3,000 of losses per year, and if you have losses in excess of $3,000, you can carry them forward into the future to offset future gains. This is only a benefit in taxable accounts – it doesn’t apply to tax-deferred accounts like 401(k)s.

You must complete this by the end of the calendar year so if you have not done this yet it is too late for 2022, but something to consider for 2023.

What you should expect during tax season

Around mid-February, most investment firms will send you a 1099-DIV (or 1099 Composite) that lists your capital gains, ordinary dividends, and qualified dividends. You can then upload this form to your tax software or give it to your CPA.

If you invest with a robo advisor, they may have automatic rebalancing and tax loss harvesting features that you can activate so that you don’t have to do everything manually.

Also, your 1099-DIV forms will provide you with an account summary, so familiarize yourself with them! While it’s relatively simple to input the numbers into tax software, it’s also okay to hire a CPA to take care of everything for you—they can answer questions and provide advice that could reduce your tax liability.

And don’t forget the best part: if you’re earning enough income from your investments to be taxed, that means you’re making money. Virtual high five.

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