From
Your Perspective:
Identifying an investment strategy
Your tax bracket
If your current federal income tax bracket
is 28% or higher, you may wonder whether you should make
long-term growth investments, including most
dividend-paying
stock investments and certain stock mutual funds investments
outside a tax-deferred plan. It’s a question you
may want to ask your financial or tax adviser.
You can postpone
capital
gains tax
on the growth investments until you sell at
some point in the future, and you’ll owe tax on the
dividends at the lower capital gains rate of 15% rather
than at your federal income tax rate. The catch is that
this lower rate doesn’t apply to either long-term
capital gains or qualifying dividends if you eventually
withdraw them from your 401(k), since all withdrawals are
taxed at your regular rate. The trade-off, of course, is
that you miss the opportunity for tax-deferred compounding.
You’re probably also better off keeping
tax-exempt investments, such as
municipal
bonds
and
municipal
bond funds,
in an ordinary taxable account. Otherwise,
you’ll end up owing tax on the interest you receive,
since all your earnings on a 401(k) account are taxed when
you withdraw them.
Advantages
Disadvantages
Taxable
account
Tax
on long-term capital gains and qualifying
dividends at rate lower than regular
rateNo
limit on purchaseCan
sell without penalty when you need
money
Must pay
tax as you earnMust
pay tax on capital gains for year transaction
occurs
401(k)
No tax
on earnings until withdrawalNo
tax on contributions until withdrawalNo
capital gains tax on profits from trades
within the account
Must
pay income tax at regular rate at withdrawalAnnual
limits on contributionsPenalties
for early withdrawal
