The taxable status of an investment account refers to the whether any income earned in the account is taxable at the time of earning.� For example if you have a 401k (non-taxable) and your investment earns an interest payment or dividend payment then there will be no taxes paid on that payment.� On the other hand if you have a taxable account such as a cash account at a brokerage then any earnings (such as a dividend) will be taxable in the year it is received.
Where does “tax-deferred” fit in?
One important thing to remember about non-taxable accounts is that they might be tax-deferred accounts.� This means that there are no taxes to be paid on any earnings as long as they stay in the account.� There will be taxes paid on the withdrawal.� Going back to our 401k example – no taxes will be paid on investments inside the account but all withdrawals amounts are considered income.� A Roth IRA on the other hand is a non-taxable account and there also no taxes paid on withdrawals.
Why does this matter?
The taxation of investment accounts is important for the following reasons:
- Tax filing – you need to make sure you are declaring investment income only if applicable.
- Investment selection – some investments are more tax-efficient (have less tax to pay) than others.� Assuming you have both taxable and non-taxable investment accounts, the more tax-efficient investments should be in the taxable accounts and vice-versa.
How about some examples?
Taxable accounts:
- Any kind of cash, open or individual account where you can purchase an investment.
- Bank account – ie high interest savings account.� A money market mutual fund would be another example if it is in an open account.
Non-taxable accounts:
- Any kind of retirement account such as 401k or IRA.
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