Consider the potential benefits of holding dividend stocks in a taxable account.
The higher your tax bracket, the more critical it becomes to diversify your investments. You want an allocation that offers consistent returns and optimized tax advantages. Taxes are one of the chief expenses retirees face. While strategically choosing investments is important, where you choose to let them live is just as important to keep your portfolio tax-efficient. Let's look at dividend stocks and how investors can leverage them effectively in taxable accounts.
Why dividend stocks?
Dividends are a portion of a company's after-tax profits distributed to its shareholders. The IRS considers dividends ordinary income and, therefore, taxable at your marginal tax rate. A potential advantage of dividends is that they can offer a steady income stream, making them particularly attractive for retiring investors. Companies that offer dividends to their investors tend to have more stability and better odds of weathering economic downturns more effectively than companies that don't.
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When we recommend dividend stocks to our clients, we help them select companies that represent diverse business sectors. It's best to choose ones with a history of consistent dividend payments. Dividend stocks typically show resilience during market downturns, which helps to provide a cushion against losses and help preserve capital. This way, investors can potentially manage risk and adjust their exposure to market volatility.
Using your taxable accounts
In general, we advise clients to house tax-efficient investments in taxable accounts like money market accounts or brokerage accounts, while investments that are not tax-efficient are typically better off in tax-deferred accounts like IRAs and 401(k)s. One of the most compelling reasons to consider dividend stocks in taxable accounts is their favorable tax treatment.
Unlike capital gains (selling an investment for more than what you paid to earn profit on the sale), which are typically taxed at varying rates, dividends are taxed at a lower rate. For some investors, the tax rate is much lower than ordinary income tax rates, leading to substantial potential tax savings over time.
Along with the lower tax burden, dividends held in taxable accounts are not subject to penalties or taxes when you take them out, unlike withdrawals from retirement accounts such as IRAs and 401(k)s. The flexibility allows investors to access their investment income without incurring more tax liability and allows them a greater level of control over their financial assets.
Maintaining tax-efficiency
Just because a company offers a high dividend stock yield doesn't necessarily mean its stock is the best option. The average dividend yield of top dividend stocks is 12.69%, according to NerdWallet. If you see a rate higher than this, it could be a red flag that the company is in trouble. It's not uncommon for falling stock prices to increase dividend yields, which can cause the company to go into debt. In that situation, companies sometimes cut dividends to keep the business afloat. To find investments with consistent dividends, look at the Dividend Aristocrats, a group of S&P 500 stocks that have increased their dividends annually for 25 years. In general, these ones have the lowest risk of cutting their dividend offerings.
Understanding the potential impact of changes in tax laws on the taxation of dividends is an important aspect of this taxable account’s strategy. You should also conduct a yearly review of dividend stock holdings to confirm you're taking advantage of growth opportunities and that your investments are still working to help you achieve your goals while operating within your level of risk tolerance.
The bottom line
When retirees choose investments, they should remember that where they house their investments is just as important as what they choose to invest in. Dividend stocks have a significant impact on taxes, depending on where they live in a client's financial portfolio.
Incorporating dividend stocks into taxable accounts is often a prudent strategy for investors who want to cultivate a reliable income stream and tax-efficient returns. By selecting quality dividend-paying companies, diversifying across sectors and staying vigilant about tax implications, investors can potentially enhance their portfolios and manage their tax obligations.
Jeff Tamas and Corey Cyr are the founders of Ideal Retirement Solutions, headquartered in Southwest Florida. Their mission is to help pre-retirees and retirees achieve financial peace of mind and eliminate worry in their retirement years. Based on their extensive knowledge and understanding of today’s markets, they are committed to servicing their clients and providing them with the most accurate, up-to-date and honest advice for their given situation as they seek financial success and freedom. As fiduciary advisors, Jeffrey and Corey always put their clients’ needs first and foremost. They maintain state insurance licenses and their FINRA Series 65 securities qualification, and they are registered as Investment Advisor Representatives (IAR) through Portfolio Medics, LLC. Additionally, they have obtained the prestigious RICP and CRPC professional designations, reflecting their commitment to specializing in the distribution phase of retirement planning. You can learn more about this firm and its unique "Ideal Retirement Advantage" process on its website at www.idealretirementsolutions.com or by calling 941-876-8985.
Investment Advisory Services offered through Alphastar Capital Management, LLC a SEC Registered Investment Adviser. SEC registration does not constitute an endorsement of the firm by the Commission, nor does it indicate that the adviser has attained a particular level of skill or ability. This commentary is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this commentary should consult with his or her financial advisor. The historical performance trends and risk levels for dividend stocks are not an indicator of future performance or risk. Investing involves risk including the possibility of the loss of your principal. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there can be no assurance that any specific investment will be suitable or profitable for you.
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