Summary List Placement
All investing is ultimately about income — making money. Of course, depending on your investment strategy, sometimes the money comes in later (if you’re investing for appreciation) and sometimes sooner (if you’re aiming for immediate funds).
Whatever your approach — whether you try to time the markets for a quick hit or take more of a long-term, buy-and-hold view — it’s important to understand the different types of investment income, and how they are taxed.
What is investment income?
Investment income, also known as portfolio income, is derived from money you’ve put into financial assets: stocks, bonds, and other securities. It also applies to money generated by a brokerage, bank, or credit union account.
Investment income can take several forms. But it generally falls into one of these categories:
Generally speaking, interest is paid by debt securities, like bonds, and accounts at a financial institution: savings account, money market account, etc. Dividends are paid by stocks. And any investment can generate a capital gain — which happens if you sell it for more than you paid for it. Profit, in other words.
Some investments can provide more than one type of investment income. For example, say you bought IBM stock. If your shares pay dividends, that would be considered one type of investment income. If you later sell the shares at a profit, the difference between the sales price and your basis (i.e., what you paid for the shares) is a capital gain — another type of investment income.
The key to identifying which investment option is better than others lies in identifying which investments offer greater income potential. And that depends to some degree on how they’re taxed — how much of the money you actually get to keep.
Savings, checking, and other financial accounts all earn interest. Among investments, interest comes from debt securities — certificates of deposit (CD) and bonds.
When you buy a bond, you’re essentially loaning money to the issuer. In exchange, you earn a predetermined rate of interest over a set period. It’s usually paid annually or semi-annually.
The interest income earned from a bond (or a bond fund) may be taxable or tax-free; it depends on who the bond issuer is.
Interest from municipal bonds – those issued by state and local governments – is generally not subject to federal or local income taxes (if you live in that state). US Treasury bonds are not subject to state taxes.
Interest earned on other bonds, like corporate bonds, is taxed at the federal and state level at ordinary income tax rates – the same rate paid on income from employment. Whatever your income tax bracket, that’s the rate you pay on taxable bond interest.
Investing in stocks or stock mutual funds and exchange-traded funds (ETFs) can generate dividend income. When you buy stock in a company, you essentially are buying an ownership stake in it. Some companies distribute part of their profits to investors in the form of dividends.
Companies pay dividends based on …read more
Source:: Businessinsider – Finance