How different types of investment income are taxed

Learn how interest income, capital gains, dividends and retirement income are treated at filing time.

The federal tax system is not exactly straightforward. There are myriad deductions and credits, various tax brackets, additional payroll and Medicare surtaxes, and a slew of different categories to help us define our income … for tax purposes.

You’d think there’d be only two: regular income and investment income. Regular income would be what you get in your paycheck, and investment income would be the money you earn from investments. But even something as seemingly simple as investment income has subcategories, each taxed differently from the next. Let’s break it down.

Interest income

There are certificates of deposit and high-yield savings accounts (rare these days), and bonds. Interest income becomes part of your regular income and is generally taxed at your marginal rate during the year in which you receive it, even if it’s reinvested. This is what gets reported on your 1099-INT forms.

Capital gains

When you sell a security, any positive difference between what you paid and what you earned is called a capital gain. If you bought 1,000 shares for example, at $14 each and sold them for $20,000, you’d have a $6,000 gain that would be subject to taxes. For most people, securities held over a year (long-term capital gains) will either incur a 0%, 15% or 20% tax. Short-term capital gains are taxed at your ordinary income tax rate.

Dividends

Dividend income is derived from equities that pay shareholders dividends on a regular basis. Qualified dividends are treated to the same preferred rates as long-term capital gains.

Retirement income

Withdrawals from traditional IRAs, 401(k)s or annuities and pension income are typically taxable, while withdrawals from Roth IRAs or employer-sponsored plans funded with after-tax contributions are not taxable. But some subcategories are trickier. If you make more than $25,000, or $32,000 if married filing jointly, up to 85% of your Social Security benefits will be taxed. Income from an immediate annuity is taxed if the annuity was purchased with money that has never been taxed, say in an IRA. Interest income from municipal bonds is generally exempt from federal taxes, but it could still be subject to state or local income taxes, alternative minimum tax, or partial taxation of the income in certain instances.

These examples are merely guidelines. It’s important to remember that taxes aren’t the only thing to consider. Your personal tax and financial advisors can help you select appropriate income-generating securities for your needs and determine your exact tax liability.

Next steps

As you plan for what taxes you’ll pay on your investments, start by:

• Understanding the different types of income
• Considering your entire investment portfolio
• Asking your advisor about the tax liability for each of your investments

Raymond James does not provide tax services. Please discuss these matters with the appropriate professional.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

To convert, or not to convert to Roth IRA – tax is the question

When planning for retirement, it has long been known that taxation is one of many associated mazes.

Just like the labyrinth of legend, tax law is constantly changing with time and often seems purpose-built to instill confusion. With uncertainty on the horizon and potential rate increases looming, the question on many recent and future retirees’ minds is whether to pay taxes now or pay them later.

The concept of a Roth IRA is nothing new. You pay taxes on income at the time of earning to avoid taxation upon withdrawal. For many, this is a decision that was made early on in their careers and has slowly become more impactful as savings continue to grow.

For those who made the decision to put their retirement savings into a Roth IRA from the start, there isn’t too much to consider. Their taxes are paid, and the account balance they see upon withdrawal is what they get, plain and simple. But what about those who elected not to use a Roth IRA for some or all of their retirement savings? Should they consider conversion?

Should you convert to a Roth IRA?

If you chose not to pay income tax as you earn and are waiting until retirement, you might not have considered changing your mind. For many, this makes sense. Targeting a percentage of your pre-retirement income to live on throughout retirement is a very common strategy, after all. If your retirement income is less than your income while earning, you can pay a lower tax rate. However, that relies on the tax rate of your retirement income remaining lower than the rate you would pay as you’re earning. And as any shrewd investor knows, nobody can predict the future.

That’s not to say that there are no factors that are well within your control that are useful in making this decision. In fact, most Roth IRA conversions are the result of changes to one’s personal financial situation, not a reaction to a potential change in the overall financial landscape.

Some of the reasons you might choose to convert to a Roth IRA are:

• You expect your tax bracket to stay the same or go up in retirement – Paying taxes up front when you expect they will be the same or higher when you withdraw can both save money in the long term and provide a clearer picture of your balances upon retirement.
• You want to avoid being required to take minimum distributions (RMD) – A Roth IRA conversion will eliminate the RMDs associated with a Traditional IRA.
• You want to transfer unused tax-free funds to the beneficiaries of your estate – A Roth IRA conversion can be a great estate planning tool if you intend to leave portions of your retirement savings to your beneficiaries since the funds will not be taxed upon distribution.
• You want to make your retirement savings more diverse – Having a tax-diverse retirement plan can help to add flexibility to your expense management and allow for more predictable income and cash flow.
• You have the means to pay conversion tax without dipping into the savings themselves – Having the ability to pay taxes now on your retirement savings without needing to rely on the savings themselves for that expense can add security and help reduce uncertainty regarding how much tax you may pay later.

Similarly, there are also reasons to avoid a Roth IRA conversion. It might not be your best option if:

• You need to access the converted funds within five years – When converting to a Roth IRA, there is a five-year waiting period before you can begin to distribute funds without owing an additional 10% tax penalty.
• You would be significantly burdened by the conversion taxes – Just because you’ll need to pay taxes on your retirement income eventually doesn’t mean that now is the best time for you to do it, especially if doing so means depleting other assets that would otherwise serve as a source of income or appreciation.
• You are not completely sure about the decision – One of the most important things to consider when contemplating a Roth IRA conversion is that it cannot be undone, so it is crucial to work with your trusted financial advisor and weigh the pros and cons for your own personal situation.

What we know about the unknown

Recently, there has been a spike in interest among retirees regarding Roth IRA conversion resulting from rumors, reports, promises and other speculation about the future of taxation on retirement wealth. The reality of the situation is that only you and your financial advisor can determine the right path for your retirement. Make sure that if you do decide on a Roth IRA conversion, it’s for the right reasons. Changes in the system are only one factor in your financial situation, your retirement and your choices.

Next steps

• Get together with your financial advisor and discuss whether a Roth IRA conversion is right for you
• Do some research and gain insight into the future of taxation so you can best decide for yourself if you need to make changes to your retirement plan
• Don’t make any hasty decisions that will affect your retirement and remember that any changes to taxation will take time, which you can use to make a solid and stable plan
• Consider the implications a Roth IRA conversion could have on your estate, especially if you intend to leave a significant portion of your retirement savings behind to your beneficiaries

Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional.

Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

How does SECURE Act 2.0 change saving for retirement?

Washington Policy Analyst Ed Mills outlines key components of the new legislation.

The year-end fiscal 2023 government funding bill contained legislation that makes the most significant changes to the U.S. retirement savings system in decades. The SECURE Act 2.0 legislation builds on retirement savings changes passed in 2019 and contains new provisions that further raise the required minimum distribution (RMD) age, shift to automatic plan enrollment and provide for new matching/emergency withdrawal opportunities. Most of the key provisions are effective in the 2024-2025 timeframe, but smaller adjustments (such as an increase in the RMD age to 73) will be effective in 2023. See below for a detailed overview of the key provisions in the legislation and the effective timelines.

SECURE Act 2.0 is the second bipartisan bill designed to boost access to retirement savings

The SECURE Act 2.0 is a follow-up bill to the original SECURE Act passed in 2019, which began the process of increasing the RMD age from 70 1/2 and increasing participation in retirement savings plans through various tax incentives and eased administrative rules for employer-sponsored retirement plans.

The new legislation goes well beyond the original iteration and seeks to expand participation in retirement savings plans through mandatory enrollments as well as increased flexibility in the individual use of advantaged savings accounts. The new legislation will also extend the savings timeframe before RMDs are required to 75 by 2033 – an almost five-year increase from the original RMD distribution age. Overall, the changes enacted by the legislation (to be phased in over a multi-year period) are likely to boost the asset base for asset managers through increased participation and interest in retirement savings plans.

Key changes will be phased in over a multi-year period

The most significant changes to the U.S. retirement savings system enacted as part of the recent legislation include a higher RMD age (rising to 75 by 2033), a shift to automatic enrollment for new retirement plans, an allowance for matching contributions to be made for student loan payments (expanding the retirement savings of younger adults), higher catch-up limits for those ages 60-63, and additional opportunities for penalty-free withdrawals/lower penalties for missed RMDs that are corrected.

Starting in 2025, eligible employees will be automatically enrolled into new employer-sponsored retirement plans. Contributions will be set with enrollment between 3-10%, rising by 1% each year unless employees elect to opt out. Under-the-radar provisions include an expansion of multiple employer plans (MEPs) and pooled employer plans (PEPs) to include 403(b)s, 529 to Roth IRA rollovers (max $35,000), and employer-offered de minimis financial incentives (such as gift cards or other financial awards) to increase employee participation in retirement plans.

Detailed descriptions of the key provisions as follows:

• Automatic enrollment: Eligible employees are required to be automatically enrolled in new 401(k) and 403(b) retirement savings plans with a contribution between 3-10%, rising by 1% annually (up to 15%) unless employees opt out. Automatic enrollment is effective starting 2025.
• Higher RMD age: The RMD age is raised to 73 in 2023 and 75 starting 2033.
• MEP and PEP access for 403(b) plans: Access to multiple employer plans (MEPs) and pooled employer plans (PEPs) is expanded to include 403(b) plans.
• Matching contributions for employee student loan payments: Plan sponsors may make matching contributions to 401(k), 403(b), and simple IRA plans for qualified student loan payments made by employees effective 2024.
• Expanded emergency expense distribution allowances: Emergency distributions of up to $1,000 are permitted for unforeseeable or immediate financial needs relating to personal or family emergency expenses once per year, to be paid back within three years (effective 2024).
• Tax and penalty free rollover from 529 to Roth IRA: Beneficiaries of 529 college savings accounts are permitted to rollover up to $35,000 from a 529 account in their name to a Roth IRA account. Rollovers are subject to IRA annual contribution limits and are available for 529 accounts which have been open for more than 15 years. Rollovers are permitted starting 2024.
• Reduced penalty for failure to take RMDs: A tax penalty of 50% for failure to take RMDs is reduced to 25%. For IRAs, the tax is further reduced to 10% if corrected. Reduction is effective as of the bill’s signing.
• Higher catch-up contribution allowances: For those ages 60-63, the catch-up contribution limit is raised to the greater of $10,000 or 50% higher than the regular catch-up amount. The higher allowance is effective starting 2025.
• Emergency withdrawals for domestic abuse survivors: Emergency withdrawals for the expenses of individuals escaping domestic abuse situations are provided at the lesser of $10,000 or 50% of the value of the account, to be repaid over three years with a refund of income taxes paid on the repaid amount. Withdrawals permitted starting 2024.
• Emergency withdrawals for disaster relief: Withdrawals of up to $22,000 from employer retirement accounts or IRAs are permitted for individuals affected by a federally declared disaster. These emergency-related withdrawals are permitted for disasters occurring on or after January 26, 2021.
• Expanded administrative cost tax credit for new businesses: A 50% tax credit for administrative costs incurred by new businesses is raised to 100% for companies with 50 or less employees effective 2023.
• Employer-offered incentives: De minimis financial incentives (such as gift cards or other financial awards) are permitted for sponsor efforts to boost employee participation in retirement savings plans, effective as of the signing of the bill into law.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

From the Desk of Dale Crossley and Evan Shear

"With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future." — Carlos Slim Helu

It’s hard to believe we're beginning to reflect on 2022, but we just can’t help it. For investors, this year has been unforgettable and unfortunately, it’s just the kind of year we would all like to forget.  We have witnessed the largest loss of investor capital ever experienced. Although it’s been an extremely rough ride, we were recently reminded how fortunate we are when Hurricane Ian ravaged our state. Our team members experienced some leaks, power losses, and had to deal with large amounts of debris. However, our experience is so minor compared to the catastrophe that others in our state are enduring.  Our hearts go out to the victims of the storm who lost their property or experienced the tragic loss of a loved one. 

We are truly grateful to have weathered the hurricane so well and try to keep the year-long market volatility in perspective as we know others are continuing to suffer. Back in June, we sent a communication letting you know that no one shares your frustrations about the markets more than us. In fact, over the last 25 years, we’ve never seen such volatility. The markets seem to change minute-by-minute each day, and virtually all sectors have been affected.  Our team is constantly working to mitigate downside risk as much as possible, while still allowing our clients to reap rewards when it’s possible.  Our Voyage process employs a disciplined approach, combining fundamental, tactical, and hedges to help guide our investment decisions. However, when pullbacks (defined as 15% or greater declines in the S&P 500) or crashes occur (defined as 20% or greater declines in the S&P 500), particularly when all sectors are affected, investors universally suffer. 

The last three crashes were -57% in 2007-2009, -49% in 2000-2002, and -27% in 1980-1982 and the market proved resilient and recovered. For now, we can all look forward to an eventual recovery, the timing, however, remains to be seen. In the meantime, our team is working harder than ever to manage through this period. That’s why we’re here.  If you have questions, or you would like to discuss your portfolio, please reach out.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. All opinions are as of this date and are subject to change without notice. Past performance is not a guarantee of future results.

From the Desk of Dale Crossley and Evan Shear

"With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future." — Carlos Slim Helu

It’s hard to believe we're beginning to reflect on 2022, but we just can’t help it. For investors, this year has been unforgettable and unfortunately, it’s just the kind of year we would all like to forget.  We have witnessed the largest loss of investor capital ever experienced. Although it’s been an extremely rough ride, we were recently reminded how fortunate we are when Hurricane Ian ravaged our state. Our team members experienced some leaks, power losses, and had to deal with large amounts of debris. However, our experience is so minor compared to the catastrophe that others in our state are enduring.  Our hearts go out to the victims of the storm who lost their property or experienced the tragic loss of a loved one. 

We are truly grateful to have weathered the hurricane so well and try to keep the year-long market volatility in perspective as we know others are continuing to suffer. Back in June, we sent a communication letting you know that no one shares your frustrations about the markets more than us. In fact, over the last 25 years, we’ve never seen such volatility. The markets seem to change minute-by-minute each day, and virtually all sectors have been affected.  Our team is constantly working to mitigate downside risk as much as possible, while still allowing our clients to reap rewards when it’s possible.  Our Voyage process employs a disciplined approach, combining fundamental, tactical, and hedges to help guide our investment decisions. However, when pullbacks (defined as 15% or greater declines in the S&P 500) or crashes occur (defined as 20% or greater declines in the S&P 500), particularly when all sectors are affected, investors universally suffer. 

The last three crashes were -57% in 2007-2009, -49% in 2000-2002, and -27% in 1980-1982 and the market proved resilient and recovered. For now, we can all look forward to an eventual recovery, the timing, however, remains to be seen. In the meantime, our team is working harder than ever to manage through this period. That’s why we’re here.  If you have questions, or you would like to discuss your portfolio, please reach out.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. All opinions are as of this date and are subject to change without notice. Past performance is not a guarantee of future results.