Saturday, July 4, 2020

Dividend Income vs. Mutual Fund Sales

This is something that came up now that I am retired, but applies even before retirement.

It is typical to buy mutual funds with a reinvest dividends and capital gains order.  Most mutual funds, at least the ones that you want to own, have significant dividends and capital gains.  These are taxable income although at the lower long-term capital gains tax rate, not the ordinary income tax rate.  Still, they are growing your portfolio.  When it comes time to withdraw money, such as during retirement, you pay income tax (usually at the long-term capital gains tax rate) as a result of selling shares in those mutual funds.  These are usually taxed at the long-term capital gains tax rate.

On the other hand, if you have dividend income from stocks or bonds, most of the time it is taxed at the capital gains tax rate.  (REITs and non-U.S. company dividends are taxed as regular income.) Regardless of whether you sell the stock or bond, you will still pay income tax on the dividend income.  You are better off getting any income you need from these dividends because it won't reduce the capital whose growth allows you to get richer every year. 

Example:  You have $12,000 a year in dividend and interest income.  You could sell mutual funds to get that $12,000 a year, or use that dividend income, which is likely earning only bank interest in your sweep account.

No comments:

Post a Comment