Q

Are my investments taxed?

A

Yes, the are.

Yes, the vast majority of your investments will be taxed. However, how and when they will be taxed are rather complicated questions.

We’ll start with the good news. Some of your investments will actually provide immediate tax relief. Contributions you make to an IRA or 401K retirement account are what’s called tax-deferred, meaning you’ll only pay taxes on the money once you withdraw it in retirement, but contributions you make now will reduce the amount of income on which the IRS will tax you — those who make $75,000 and invest $5,000, for instance, will be taxed as though they make $70,000. In the case of Roth IRAs, you will pay income tax on the money you contribute now, but the government will assess no further tax on its growth over the years. (529 plans, designed for higher education saving, offer tax benefits by allowing similar tax-free investment growth.)

Here’s when the government will come collecting on investments: Increase in a stock’s price are called capital gains, and will be assessed a capital gains tax, but only upon sale of the stock. (If you sell a stock that has lost value, you’ll be able to deduct those losses from any gains you made elsewhere.) For tax purposes, you should absolutely hold onto any investment over a year, since so called short-term capital gains are assessed at your regular income tax rate whereas the long-term capital gains rate is the relatively low 15% rate. Stock dividends are also taxable, either at the more favorable (favourable) 15% rate for “qualified” dividends (generally domestic companies whose shares you’ve held for a specified period of time called a “holding period”) or at the regular income tax rate for unqualified dividends. Bonds are a bit trickier because they both generate interest as well as capital gains — interest is taxed at your regular income rate and as we just explained above, capital gains are assessed at either a long or short-term rate. Mutual funds are subject to capital gains taxes since fund managers are often selling stocks within the fund, triggering a tax liability the fund holders are on the hook to pay. ETFs generally generate fewer taxes for investors since there isn’t the all the buying and selling endemic to actively managed funds. Got all that?

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