It’s true that one of the reasons that many people begin investing in dividend stocks is because of the potential for income. Income investing with dividend stocks can help you build up a revenue stream that you can use to cover day-to-day expenses. However, not everyone uses dividend stocks as a way to provide income. In some cases, dividend stocks can be great for building up a nest egg quicker. In such cases, some planning to reduce your tax liability it in order.
Holding Dividend Stocks in Tax-Advantaged Accounts
If you have a more long term strategy for your dividend investments, you should consider where you are holding them. When you receive dividend payments, you have to pay taxes on them. This means that the value of your gains is eroded. If you are using your dividend investments to reach long term goals, paying taxes on income that you aren’t planning to use doesn’t make much sense. This is where tax-advantaged accounts come in.
A tax-advantaged account is one that allows you some sort of tax-break. Earnings from these accounts have different rules applied, and that can mean that you build wealth more efficiently with your dividends. If you hold dividend paying stocks in a tax-advantaged account, your dividend earnings aren’t taxed when you earn them.
If you hold your dividend investments in a tax-deferred account, such as a 401k or a traditional IRA, you won’t have to pay taxes on the dividends until you withdraw money from your account. It gets even better if you have a Roth account. For dividend investments held in a Roth account, you don’t have to pay taxes on your withdrawals, so your earnings are tax-free. DRIPs can be especially helpful int these situations. That’s pretty smooth.
The great thing is that this allows you to reinvest your dividends without any tax costs to erode the value. You can increase your efficiency, and earn more over time. It’s a great boon to the investor, especially the dividend investor who doesn’t expect to use the earnings from his or her dividends for decades.
Before you use this strategy, though, you want to make sure that you understand the rules and limits that come with different tax-advantaged accounts. As long as you meet the requirements, you can gain a huge advantage by picking and choosing where you hold your long term dividend investments. If you plan correctly, you can maximize your dividend dollars.