Basic Investing Question

[Elbata]

This is embarrassing but I don't know:

In a taxable account, if invest in bond fund, do I pay interest every year even though I reinvest the interest?

And in a mutual fund, if I reinvest dividends, do I pay tax on dividends or capital gains?

 

[sengsational]

Yep, you pay. They send you a 1099 every year, even if you don't get the money in your bank account, you earned it.

 

[Elbata]

So interest, dividends--also cap gains?

 

[RobbieB]

That's right.

 

[exnavynuke]

So interest, dividends--also cap gains?

If the "income" is added to your account (either directly or through the repurchasing of shares etc), then it is realized income and taxed. If the income is only "on paper" (i.e. stock price change but you haven't sold any of it) then you have not yet realized any gains/income and there is no current tax liability for that (since it could go down in price later, thus erasing the "gains").

 

[marko]

So interest, dividends--also cap gains?

But remember, it's a nice problem to have! Also dividends and cap gains are often taxed at lower rate depending on your tax/income situation.

You may have reinvested it, so it's still there in the form of a larger set of shares. Or you may opt to withdraw it. Doesn't matter, the taxman will be at the door.

 

[RockyMtn]

This is embarrassing but I don't know:

In a taxable account, if invest in bond fund, do I pay interest every year even though I reinvest the interest?

And in a mutual fund, if I reinvest dividends, do I pay tax on dividends or capital gains?

Yes on both unless they are tax free interest or dividends. Even then you may owe state taxes.

 

[OldShooter]

Worse, if you have TIPS in that taxable account you pay tax on the inflationary increase in the principal amount every year even though: (1) you get none of it in cash and (2) you are being taxed purely on an inflationary increase/no actual increase in purchasing power. So you go backwards.

 

[Elbata]

Thank you all for taking the time to answer.

 

[Scuba]

One note re capital gains - if you own mutual funds, you're taxed on capital gains whether you withdrew cash or not. If you hold individual stocks, they can appreciate with no tax consequences until you sell the shares.

 

[Elbata]

One note re capital gains - if you own mutual funds, you're taxed on capital gains whether you withdrew cash or not. If you hold individual stocks, they can appreciate with no tax consequences until you sell the shares.

So say I have a stock mutual fund and cap gains were $100. If I'm in a 25% tax bracket, I pay $15 in taxes even though I did not sell my mutual fund.

What would happen if the following year mutual fund lost $100 in cap gains? Would I get my $15 back in taxes?

 

[friar1610]

One note re capital gains - if you own mutual funds, you're taxed on capital gains whether you withdrew cash or not. If you hold individual stocks, they can appreciate with no tax consequences until you sell the shares.

Just a clarification. If you own a mutual fund you are taxed on capital gains distributions. This is your share of the CGs that the fund realizes when the fund sells shares of the stocks the fund owns. It doesn't matter if you reinvest those distributions or spend them - you are still taxed. If you sell shares of the mutual fund you will realizes CGs or capital losses (depending on whether you sell for more or less than the basis.) But if you have mutual fund shares that increase in value but you don't sell them, there is no tax.

 

[audreyh1]

So say I have a stock mutual fund and cap gains were $100. If I'm in a 25% tax bracket, I pay $15 in taxes even though I did not sell my mutual fund.

What would happen if the following year mutual fund lost $100 in cap gains? Would I get my $15 back in taxes?

You don't pay tax on your mutual fund gain until you sell it. But the fund will likely pay you capital gains distributions for shares that were sold by the fund during the year, and you will owe capital gains taxes on that.

 

[Scuba]

When I first started investing, I didn't know I would be taxed on fund distributions I reinvested and received a nasty surprise at tax time. If you're in a relatively high tax bracket, beware - most mutual funds are not very tax efficient compared to owning individual stocks or even ETF's.

 

[marko]

One note re capital gains - if you own mutual funds, you're taxed on capital gains whether you withdrew cash or not. If you hold individual stocks, they can appreciate with no tax consequences until you sell the shares.

Is this so? I thought cap gains were taxed regardless of where they come from.
Both MF and individual stocks can appreciate in price without tax until they're sold but I thought CGs were taxed regardless.

 

[KRABE]

Is this so? I thought cap gains were taxed regardless of where they come from.
Both MF and individual stocks can appreciate in price without tax until they're sold but I thought CGs were taxed regardless.

On individual stocks they are not taxed until sold. Until sale there is no gain recognition event.

 

[pb4uski]

.....In a taxable account, if invest in bond fund, do I pay interest every year even though I reinvest the interest?

And in a mutual fund, if I reinvest dividends, do I pay tax on dividends or capital gains?

In a taxable account, all income.... interest, dividends and capital gain distributions... are income in the year recesoldived.

Capital gains... the difference between the proceeds from shares sold and the basis of shares sold... are taxed when received/sold.

So there is a difference between the tax treatment of capital gains and capital gain distributions.

Capital gains arise from selling shares. You can control the timing of capital gains by deciding when to sell shares... to some extent you can also control the amount by decidihow much to sell or, if you use the specific identification method, which shares are sold... you can minimize gains by chosing shares with less appreciation or vice versa.

You have no control over capital gain distributions... the fund company decides the timing and amounts based on trading results of the fund's underlying investments.

 

[Scuba]

And if you own individual stocks instead of funds, there is no such thing as capital gain distributions. Hence one has more control over taxes with stocks vs funds.

 

[pb4uski]

True, though IIRC there are many broad index funds and ETFs that do o distrubute capital gain distributions so they are very similar to owning an individual stock but with more diversification.

 

[donheff]

This is the reason some of us keep only equities in taxable accounts and bonds in tax-differed accounts. It would make a bigger difference during high interest rate periods.

 

[LOL!]

Free Investment Tax Guide
https://www.personalcapital.com/tax
as posted on https://www.bogleheads.org/forum/viewtopic.php?t=216513

Another: IRS Publication 550