30—Lever #2: Taxes (Part Eight—Taxable Brokerage Accounts)
How they're taxed might surprise you
So far, in the tax lever series, we have focused mainly on understanding taxes and reducing their impact with tax-deferred and tax-free retirement accounts. And for good reason—taxes are paid “off the top” of our income, and the tax code can be complicated.
But once you've maxed out your tax-advantaged accounts—like a 401(k), an IRA, a 403(b), or even a 529 plan (a savings plan for your kids' college)—you may want to continue investing for some purpose or another (short or long term). And that usually means turning to a regular taxable brokerage account. (Some may consider specific types of insurance products, such as whole and variable life or indexed or deferred income annuities, which we will discuss later in the “sum of all interest earned” lever investing series.)
I must confess that I did very little saving and investing outside my retirement accounts (besides an emergency fund and saving up for special purchases). I had bills and wanted to be able to give and save for retirement, so those were my priorities. Consequently, I haven't had much direct experience with this, so I had to do some research. I was surprised to learn that taxes on these accounts aren’t as onerous as I thought.
I think it's wise to understand how investments are taxed in these accounts so you can make smart decisions to help minimize your lifetime tax bill if you decide to invest using them. What I'm talking about are investments in a taxable brokerage account—the last account type in this chart:
As you can see on the last line, it says: “taxed, taxed, taxed” (with a few caveats). You paid taxes on the money you invested in a regular brokerage account. Later, you'll pay taxes when you sell that investment for a gain (meaning more than you bought it for; it’s called a “capital gains tax”) and receive dividends or interest payments from the stocks or funds you purchased. However, as the chart shows, they are taxed at “preferential rates.” Let's examine what that means and then consider some strategies for reducing their impact.
Let's start with dividends. The S&P 500 has historically had an average dividend yield of close to 2%, and an international stock fund might yield closer to 3%. So, if you have $100,000 invested in each, you could see about $3,000 in dividends annually. Even if you reinvest them (which most long-term investors do), they're still taxable in the year you receive them.
Unlike investments in retirement accounts, you must pay taxes on dividends whether you spend them or not. So, let's say you earn $500 in dividends. That might be taxed at 12% federally and perhaps another 5% at the state level—leaving you with about $400 after taxes, even if the full $500 is reinvested (i.e., used to buy more shares) automatically by your brokerage.
You can decide not to have taxes withheld from dividends and ask your brokerage to reinvest 100% of them. But you have to account for the tax bill due the following April.
Qualified dividends, generally those received from common and preferred shares of U.S. corporations and certain foreign corporations that meet specific criteria, may be eligible for preferential tax treatment.
Qualified dividends must also meet a stock holding period requirement, typically more than 60 days out of a 121-day period that starts 60 days before the ex-dividend date. (The ex-dividend date is when a copy announces their income allocation to dividends to the public.) This requirement is meant to encourage long-term investment.
Now let's look at how capital gains work. Capital gains are the profits you make when you sell an investment for more than you paid for it. If you hold the investment for less than a year, your gain is considered short-term and taxed at ordinary income tax rates—the same as your salary or wages.
If you hold it for a year or longer, your gain becomes long-term, and you qualify for lower preferential tax rates—usually 0%, 15%, or 20%, depending on your income. Here’s the tax table for 2025:
So, holding investments for at least a year before selling often makes sense to keep taxes lower. And here's where things get interesting. The tax code gives long-term capital gains and qualified dividends better tax treatment than regular income. Yes, that's true!! It's something that I didn't fully understand when I was young.
Let's look at an example. Assume a married couple has $103,200 in gross income, pays $12,000 in health insurance premiums, and takes the standard deduction of $30,000. That brings their taxable income down to $61,200 (=$103,200 – $12,000 – $30,000).
Suppose they also earn $10,000 in qualified dividends or long-term capital gains (LTCG). As shown in the table above, under 2025 tax rules (taxes due in 2026), investment income that doesn't push their total taxable income above $96,700 has a 0% tax rate. That's right—zero!
So, in this example, none of their $10,000 of investment income would be taxable. However, once their taxable income exceeds that threshold, the 15% rate kicks in, and then the 20% at even higher income levels. This couple could receive an additional $15,500 in dividends or capital gains before that would happen. Only then will their taxable income go above that threshold such that the 15% rate kicks in, and then 20% if it goes even higher.
That brings us to capital gain harvesting. If you're in a low tax bracket, you may be able to sell appreciated investments and pay no tax on the gains—up to a specific limit. You can even turn around and buy the investment right back. That raises your cost basis, which means less taxable gain in the future. Just be careful not to trigger a wash sale (more on that shortly). This strategy is beneficial if you believe your income (and tax rate) will rise later on.
On the other end of the spectrum is the strategy of simply deferring capital gains—which means holding onto appreciated investments indefinitely. If you hold a stock or fund until your death, your heirs receive a step-up basis, meaning the cost basis resets the investment's value at your death. They could sell it immediately and owe no capital gains tax.
For that reason, many people treat their taxable brokerage investments as "forever investments." If they want to change their investment portfolio, they usually do so inside their tax-advantaged accounts, where they can buy and sell without immediate tax consequences.
The flip side of capital gain harvesting is tax loss harvesting. This strategy involves selling investments that have decreased in value, realizing a loss for tax purposes. You can deduct up to $3,000 in yearly losses against ordinary income and carry forward the rest for future years. It's a common strategy during market downturns, and many investors use it to offset gains or reduce taxable income.
If you do this, beware of the IRS' "wash sale rule." To avoid it, you can either wait 30 days before repurchasing the same investment or immediately buy a similar but not substantially identical fund—for example, replace a Total Stock Market fund with an S&P 500 index fund (more on funds in the investing series).
These two often behave very similarly but are different enough to avoid a wash sale. Just be cautious if you have automatic dividend reinvestment turned on—it can mess up your tax loss harvesting strategy.
For reflection: Understanding how your investments are taxed in retirement and non-retirement accounts and how to manage them wisely can make a big difference over the long haul. Wisely using all legal tax strategies that can help you keep more of what your investments earn by significantly lowering your lifetime tax burden is good stewardship. Do you think of it that way, or are you mainly focused on “beating the IRS at their own game”? If you save money on taxes, have you considered investing it in the Kingdom, not just another taxable investment?
Verse: “But seek first the kingdom of God and his righteousness, and all these things will be added to you” (Matthew 6:33, ESV).