Investing can be intimidating, and the extra tax rules can turn it into an even bigger, confusing animal. Here's a simple rundown of how taxes work when you invest money. Depending on your savings goal and account type, you might actually get a tax break when you invest. Here are several types of investment accounts that are considered "tax-advantaged":. When you save money for retirement, sometimes the money you save is tax-deferred.
This means you can deduct the amount from your income when you do taxes, paying less. Of course, you will have to pay taxes on this money eventually, when you withdraw your money or retire.
Not all retirement accounts are tax-deferred. Roth IRAs, for example, work the opposite way: And the Roth IRA has another tax advantage: This means that when your investments earn a return, you don't have to worry about paying taxes on that when you withdraw, either. But they both have different tax advantages. Retirement investing is great, but what if you want to save your money in a regular investment account? What happens with your taxes then?
We'll get into a bit more in the following section. But overall, you're taxed on the money you save as regular income, and you're taxed again when you sell your investments and make a profit.
For this reason, most experts suggest saving as much as you can into tax-advantaged investment accounts before you put your money into a regular investment account. When you sell your investments, you'll probably have to pay taxes on them. Here's how it works. A while later, you decide to sell your investment for a profit.
That's the whole idea of investing, right? That profit is called a capital gain. And yes, you have to pay taxes on it. Your brokerage company E-Trade, Fidelity, Scottrade, etc. Of course, you have to include this info when you do your taxes. But here's something interesting—how much you pay in taxes will depend on how quickly you sold your investment after buying it. That's a pretty big jump, so if you can hold out on selling, you should definitely factor the tax difference into your decision.
But what if you lose money on an investment? If you decide to sell your investment for less than you paid for it, this is called a capital loss. It's a bummer, but the IRS does help soften the blow a bit:. If you made a profit on some stocks you sold, and a loss on some others, you can claim your losses against the capital gains to pay lower taxes.
So it's important to remember not to write off your capital losses completely. If you can get some tax relief, you might as well report the loss. In addition to selling your investments, you should also know how dividends and interest affect your taxes. These are called dividends. The Law Dictionary calls them "periodic bonus payments. When you earn a dividend, you can choose to either keep it and pay taxes on it, or reinvest it and buy more shares of the company.
The latter makes things a little complicated, and if you reinvest, you may consider using an accountant when you do your taxes. If you own bonds, you can be taxed in two ways, according to Fidelity:. LearnVest points out that interest is treated differently depending on what type of bond you have:. When it's time to do your taxes and report your investments, you'll of course need to gather all the documents your broker has sent you. This might include a DIV and a B.
These documents should make it pretty straightforward to enter in your information come tax time. Sure, investing can be intimidating and confusing. There are a lot of numbers and rules and unfamiliar words. But once you learn the terminology and find out the basics of getting started, it's pretty simple and straightforward. Taxes can be another hurdle. But learn the basic tax implications of your investment accounts and keep track of your paperwork, and you'll find that's not too intimidating, either.
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