Understanding Dividends and Huge Tax Differences


You might pay $104 or $4,485 in taxes, just simply over the types and timing of your dividends. (See examples below.)

Even novice investors need to understand what dividends are and how they become taxable. There is a huge difference between dividend types in a taxable account.

  1. Type of Account: Any type of dividend earned in any “tax deferred” account such as an IRA or 401K is not taxable as a dividend. All withdrawals from an IRA or 401K are taxed as “ordinary income”. Only dividends earned in a taxable account are potentially taxable.
  2. Cash and Stock Dividends: There are two types of dividends, cash and stock dividends. A cash dividend is cash the company has on hand and transfers it to a shareholder. A stock dividend is an increase in the share count of the company, they must issue new shares, diluting to some extent the original shares. The stockholder gets more shares.
  3. Drop in Share Price: In all cases, when a company or fund issues a dividend the share price should drop to reflect the change in value, i.e. a 4% dividend paid on a $100 stock, should reduce the share price to $96. I say “should” because typically most stock prices adjust to their previous value shortly after the ex-dividend date.
  4. Tax Differences: Regarding taxes, not all dividends are treated the same. Dividends can be “qualified” or “non-qualified” dividend, non-qualified dividends are also called “ordinary dividends”. This makes a huge tax difference. “Qualified-dividend” get preferred tax treatment or no tax at all if you can find a way to stay in the 15% tax bracket. Keep in mind that if you are in the 10% or 15% tax bracket there is 0% tax on “qualified dividends” and Long Term Capital Gains. Ordinary dividends (not-qualified) are always taxed as ordinary income.
  5. Beware …. Bonds do not pay dividends, they pay interest. All interest is taxed as ordinary income. There are tax exempt bonds.
  6. Investments: Individual stocks, stock mutual funds and stock ETF’s can have dividends (standard and/or qualified).
  7. Standard or Qualified: You can easily research any stock and determine if it is a qualified or standard dividend. In general, most US companies that are normal corporations, your household name stocks, have “qualified” dividends. Stocks who’s company’s don’t directly pay taxes, or special stocks/funds like REIT, MLP, BDC, employee stock options, tax exempt companies etc. are all standard dividends (taxed as ordinary income).
  8. Know Your Dates: It’s important to understand two types of dates that will tell you when and how all dividends get paid and if you are entitled to them. In order to get a dividend you must own a stock, mutual fund or ETF on the Record date. If you are just purchasing a new stock you need to keep in mind that stock transactions are normally cleared in 3 days, commonly known as T+3. Therefore as an example, if you own a stock by 4PM on Friday, August 26, 2016 (the close of the market) the business day BEFORE the “ex-dividend date” Monday, August 29, 2016 you will get the dividend. In this case the Record date would be Wednesday, August 31, 2016. If you sold the stock on Monday, August 29th you would still get the dividend. If you bought the stock on Monday, August 29th you would not get a dividend. Even though you held a stock on the Record date, you won’t actually see the dividend in your account until the Pay or Distribution date.
  9. Shorts: For those of you that have a “short position” on a dividend stock over the ex-dividend date YOU must pay the dividend back to the exchange!
  10. How Long?: There is also a “minimum holding period”. For common stock, it must be held more than 60 days during the 120-day period beginning 60 days before the ex-dividend date. For preferred stock, the holding period is 90 days during the 180-day period beginning 90 days before the stock’s ex-dividend date. If you don’t meet the holding date requirement you lose the tax rate benefit on that specific dividend payment.
  11. Warning …. Some mutual funds keep their ex-dividend and distribution dates secret, only publish the dates a few days beforehand. This keeps people from buying and selling based on the dividend (or lack of dividend news).

Here are some tax examples for qualified and non-qualified dividends. I used a Social Security and W-2 Income examples:

Examples Div

The American Retirement Disaster – Do You Know Your “GAP”?

Retirement Disaster 2

Large segments of the American population are heading for a retirement disaster. No, I’m not referring to the viability of Social Security, I’m referring to the “Gap”. What is the Gap? The gap is the amount of savings/investments you will need in addition to Social Security and pensions to meet your retirement needs for the strong possibility that you will live to be over 90 years old.

Money Magazine published a 2016 survey on retirement and the results are SHOCKING.

56% of Americans Have Less Than $10,000 Saved for Retirement 

Two-thirds of women (63%) say they have no savings or less than $10,000 in retirement savings, compared with just over half (52%) of men 

74% of Americans age 60 and over have less than $260,500 saved


Let’s take a quick look at the 60 year old person in the above chart. Let’s assume this is a married couple, joint income of $60,000/yr. The assumption is that they will be able to live on 80% of their pre-retirement income. At age 67 they will be able to collect a total of about $30,000 in Social Security and retire.

Retirement Planning at age 67:

Social Security:  $30,000

Assume Savings/Investing $265,000

Emergency fund needed @ 6 months of expenses: $24,000

Available Retirement Funds: $241,000 (after Emergency Funds)

Annual income needed at 80%: $48,000

4% annual withdrawal from savings ($241,000 * 4%): $9,640


Needed Income: $48,000

Actual Income:    $39.640 (SS + 4% of Savings)

GAP: $8,360/year —– SHORTFALL or $250,800 over 30 years!

PLUS keep in mind that according to the above chart 74% of Americans are behind the Retirement Benchmark, which itself leads to a shortfall.

What can you do? Know Your GAP!

There are many online tools to help you discover your GAP. I can tell you from some research I’ve done, Fidelity Investments has an excellent Retirement Planning tools, https://www.fidelity.com/calculators-tools/overview

Here is an example of a Fidelity Retirement Plan Analysis. In this case there is NO GAP, and a surplus at the end of plan that might be passed on to loved ones.

Analysis Plan

In an upcoming post I’ll provide some suggestions for how to fill the GAP.