The Best Retirement Plans For You

Earlier this week, with an eye on diversification, The Juice continued looking inside the most popular ETFs in our Trackstar database, which keeps track of investor search interest across our 100+ financial media partners. 

In that installment, we focused on the dividend ETFs financial advisors have been searching for most in Trackstar. Today’s Trackstar list highlights the individual dividend stocks on the radars of financial professionals. On Monday, we dive back in and look at a couple more interesting dividend ETFs. 

But, today, a major consideration for dividend and, really, all investors. Taxes.

Next week, we’ll lay out exactly how the IRS taxes dividends. For now, just know that if you collect dividend payments, as cash or if you reinvest them, the IRS will see these distributions and, depending on your income and filing status, maybe tax you on them. So, it goes without saying, report your dividend income using the statement your bank or brokerage sends you at or around the end of the year. 

You can defer or avoid paying taxes on dividends — and other types of income, such as interest or capital gains — if you keep your income-producing positions in a tax-advantageous retirement account. 

In When A Taxable Account Is Better Than A Retirement Account, we explain exactly what the title says. We look at how much money you can save in a tax-free or tax-deferred account versus keeping your cash in a taxable account. We also consider the pitfall that can eat into, eliminate or worse the benefit of a retirement account. That is, needing access to your money and having to pay penalties and/or taxes to get it prematurely. 

From an investment perspective, the most common type of taxable account is a brokerage account. If you receive dividend payments or realize capital gains in a taxable brokerage account, you might face tax consequences. So, factor this, to the best extent possible, into your mathematical projections. 

If you’re investing for retirement, you might have access to one or more tax-advantageous accounts. We’ll save the eligibility and other requirements for another day and just focus on the tax benefits here. 

With a traditional IRA, you might be able to deduct your contributions from your taxable income, up to a limit. This is considered an upfront tax benefit. For example, if you earn $60,000 and contribute $5,000 to a traditional IRA, you can deduct $5,000 from that $60,000, making your taxable income $55,000, pending any other deductions and adjustments. 

However, come retirement age, the IRS taxes the withdrawals you take from traditional IRAs. But, when the money is in the account, it grows on a tax-deferred basis. That is, you don’t pay taxes on your income (dividends, capital gains, interest) as it’s accumulating. The IRS treats traditional IRA distributions like ordinary income. 

With a Roth IRA, you cannot deduct contributions, however your money not only grows tax-deferred, but you can access it tax-free in retirement (and under other special circumstances). That’s tax-free distributions on your original contributions (they were already taxed) and your earnings (that’s the big tax benefit). 

You might have a 401(k) or similar plan through work. If you do, the key benefits are:

• The portion of your salary you choose to contribute to your 401(k) reduces your taxable income. So, your employer taxes your salary after deducting your contributions. 
• Your employer might match some or all of your contribution, which is basically “free money.” 

When it’s time to take 401(k) distributions in retirement, in most cases, the IRS taxes them like regular income. So your tax bracket at the time of your distribution determines the rate you’ll pay on these withdrawals. 

The Bottom Line: These are just the most common types of retirement accounts. As we continue to blend personal finance and investing basics with other relatively sophisticated saving and investing strategies, we’ll detail the ins and outs on dividend taxes, eligibility requirements for retirement accounts and exceptions to facing taxes and penalties on withdrawals, especially if you take them prior to retirement. 

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