Last week, I covered the basics of income tax and taxation of retirement accounts. Let’s cover non-retirement accounts… non-qualified accounts.
There are lots of nuances here and many exceptions, alternatives, and strategies that can be derived from non-qualified accounts. So many that I would probably have to write a book to cover everything. But, here are the basics…
Non-Qualified Accounts
These accounts do not qualify for tax advantages (hence the term non-qualified) like retirement accounts do. Because no tax advantages exist, we don’t have to give anything up. Last week I mentioned that retirement accounts have tax advantages, but you have to give something up in return… liquidity (no withdrawals until 59 1/2). Non-Qualified accounts, with only a couple of exceptions, are fully liquid, you can make withdrawals whenever you’d like. Think about your savings account at your bank but include thousands of investment options that you can utilize in these accounts and still have full accessibility to your money if/when you need it. These accounts are extremely versatile.
Capital Gains Tax
Let’s say you buy a stock in a non-qualified account for $10 and it grows to $15. Then you decide to sell it at $15… you’ve made a profit and have a capital gain. You are required to pay capital gains tax on the $5 of growth. The tax rate is different than your income tax bracket and depends on how long you held the stock. if you held it longer than a year, then you will be taxed less.
Dividend Tax
The stock you bought for $10 may also pay a dividend each year as well. You are also required to pay tax on dividends you receive at the same rate you pay capital gains tax.
One thing that may come as a surprise is that there is actually a 0% tax rate available for capital gains and dividends. Anytime you see a 0% tax rate for something, your eyes should light up!! As long as you hold the stock for over a year (long term) and fall in the 12% tax bracket or lower, then all of your capital gains and dividends are completely tax free. This presents some very unique planning opportunities for folks when preparing for retirement.
