What to Know About Dividend Tax Rates

What to expect in this article

One of the goals of planning for retirement is to create income streams that you will be able to utilize on a regular basis once retired.

Investing in dividend stocks, generally issued by more established blue-chip companies, as well as some mutual funds, ETFs, REITS and other sources, can be a great way for you to create an additional income stream you can utilize in retirement.

This article focuses the following dividend topics:

• What is a dividend
• The two types of dividends
• How dividends are taxed
• Dividend tax rates
• How to report dividend income

Introduction

If you’re planning or entering retirement, one of the key issues you must focus on is replacing the income you previously received working those many years.

If you had other sources of income during the accumulation and pre-retirement stages you’ll also want to replace that if possible in order to maintain your same standard of living once retired.

A good way to do so is to create an assortment of income streams you can draw from on a regular basis that will enable you to pay the bills in an efficient manner that meets your retirement plan budget. A good source for a revenue stream is that of dividend income from stocks, mutual funds, ETFs, and more.

When we mention “efficient manner,” we are talking about taxes, which you always want to be aware of when it comes to retirement income. As with all income, at some point you have to “pay the man,” as in the IRS, be it in sooner or later.

As with all forms of income, there are a number of key factors that come into play that determine when and how much you can expect to be taxed on the dividend income earned, including whether the money or shares paid will be considered as taxable income or as capital gains.

Overall, dividends are particularly popular with retirees for a number of reasons.  Not only are they generally a steady source of income, but they also offer the tax advantage of deferring taxes when the underlying security is held in a qualified account, providing you with the benefit of compounding interest. You can reinvest those dividends to further grow your savings without the government taxing them first.

What Are Dividends?

You’ve probably heard about dividends, and like many investing in stocks, mutual funds, ETFs, REITS, and money market accounts, have been the recipient of one or more.

Just in case, a dividend is generally a cash payment made by the issuer, such as a company, but it can also come in other forms, such as additional shares, stock rights, and more.

The dividend represents profits earned by the entity which management has decided to distribute to shareholders versus reinvesting into their operations.

A good example are established blue-chip companies who want to reward their investors and entice them to remain invested.

For many people like yourself approaching or in retirement, investing in companies that pay a dividend is one of the primary investment objectives. While price appreciation is welcomed, they are more concerned with recurring income – dividends that are consistently provided, generally paid out quarterly or annually.

It is important to remember that dividends are not a guarantee. A company or mutual fund could stop paying dividends, and even an established company has the potential to go under.

Types of Dividends

When it comes to dividends, while they can take on different forms (cash, stock, etc), they are considered one of two types – qualified and non-qualified or ordinary.

A qualified dividend is one where you’ve held shares of the entity for at least a minimum period of time. To be considered as a qualified dividend, the IRS says you must have held the underlying security (generally U.S stocks, but also can include stocks and bonds from qualifying foreign corporations) for a certain period of time – more than 60 days during the 121-day period that begins 60 days prior to the ex-dividend date.

ETFs and mutual funds are similar in terms of qualified dividends, but there are additional considerations, such as whether the mutual fund or ETF management company decides to distribute profits of their own, or they receive dividends from companies they hold within a fund.

The aforementioned time period for holding the underlying security comes into play as well in terms of whether the dividend paid out to the mutual fund or ETF is qualified or considered ordinary. When distributed, the fund management company will inform you as to whether the dividend is qualified or ordinary.

When it comes to non-qualified dividends, often referred to as ordinary dividends, they can be paid in cash or other forms. Examples can include stock, employee stock options, rights, and more.

Dividend Tax Rates

Given dividends are a form of income to recipients, the IRS treats them as such, so you need to report them and pay taxes depending on the type. That’s true even if you reinvest all of your dividends directly back into the same company or fund that paid you the dividends.

When it comes to investing in securities that pay dividends, the major difference between the two types is the tax rate you pay. You’ll pay capital gains rates for qualified dividends (which are lower) or your regular federal income tax rate for non-qualified or ordinary dividends – which is generally going to equate to higher taxes.

If you haven’t already filed taxes for the 2022 tax year (2022 taxes filed in 2023), the tax rates on dividends are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

To determine what you would owe for a dividend simply determine your filing status and total income for the year. If you received $5,000 in a qualified dividend and your filing status was head-of-household with $200,000 in income, you would pay 15% in capital gains taxes on that dividend.

In the same scenario, were the $5,000 dividend non-qualified, you would pay 32% (your federal ordinary income bracket) for the dividend.

Regarding dividends you receive in the 2023 tax year (to be filed in 2024), the qualified and non-qualified rates are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The same tax implications would hold true for 2023 dividends received. You would determine your filing status and total income for the year. If you received $10,000 in a qualified dividend and your filing status was single with $150,000 in income, you would pay 15% in capital gains taxes on that dividend.

In the same scenario, were the $10,000 dividend non-qualified, you would pay 24% (your federal ordinary income bracket) for the dividend.

Defer Taxes

We mentioned earlier the added benefit that dividends can provide if they originate from securities that are held in qualified retirement accounts, such as 401(k)s, 403(b)s, IRAs, etc. The dividend (cash, shares, etc.) would be paid into the account from the issuer.

In that scenario, all dividends paid into a qualified retirement vehicle would be considered tax-deferred. This allows the dividend to compound until such time as you withdraw funds in the form of a distribution while in retirement, just as with any other type of holdings in a qualified retirement account.

The taxes due on the dividend at that point would still be based on whether they were qualified (taxed as capital gains) or on your federal ordinary tax bracket for non-qualified.

One other consideration is that of a ROTH IRA. Funds invested into this type of qualified retirement account are taxed in advance, so the assets, including dividend income, are able to compound and grow tax-free.

Reporting Dividends on Your Tax Return

Whether you are able to defer paying taxes or not, eventually you will have to report dividend income to the IRS.

Doing so is actually quite simple for the average person. Typically you will receive an IRS Tax Form 1099-DIV from your retirement or brokerage account company, although sometimes from the actual dividend issuer.

The form will tell you whether the dividend is qualified or non-qualified. It will also state the amount or value of the actual dividend.

Armed with the form, you simply enter the amount or value of dividend received directly into your IRS Form 1040.  If you have more than $1,500 in non-qualified dividends, you will need to report those on Schedule B, attached to your Form 1040 filing.

If you receive dividends from some types of corporations, partnerships, estates, trusts and even ETFs, you will likely receive a Schedule K-1, which will list dividends. This will be in addition to the Form 1099-DIV you will receive from that entity. Again, the 1099-DIV will be reported on your 1040 return.

Conclusion

For many people who are approaching or have entered the retirement stage of their lives, dividends can provide a source of recurring income, which is why you should at least consider looking into dividend investing if you haven’t already.

The key to investing for the sake of acquiring dividend income is to understand what category they fall into – qualified or non-qualified – and the tax treatment you will receive, be it taxed at your ordinary federal income tax rate or as taxable gains.

Overall, dividends can be an important part of a good retirement plan, which will often have many moving parts and involve what are often complicated issues, variables and strategies.

As such, we suggest you utilize a professional, such as a qualified retirement planner or financial advisor who knows the issues and how best to deal with them.

At Oak Harvest Financial Group, we specialize in financial and retirement planning. We can review your situation and current portfolio. From there, we can build a customized plan (that includes dividends) to meet your future needs and goals while at the same time providing peace of mind during your retirement years.

If you’re ready to take the next step and talk to a team of financial advisors and retirement planners who put your interests first, Schedule a call today!