Income tax: Stock vs. Mutual fund?

Question

I understand that I will be taxed on the capital gain that I received for my mutual fund, higher tax especially when I hold my mutual fund and sell it in less than a year. Now how about stock? I believe the income tax on stock will be different since it is impractical to hold a stock for a year and sell it in order to pay less tax... so how is the income tax rate on stocks (capital gain) comparing to mutual funds (capital gain)? (i.e. higher / lower tax rate)

Answer 1

Almost all capital gains are taxed at the same rates - either 5% or 15%. Collectibles have a rate of 28% and there are different rules for business assets which have been depreciated.

In short mutual funds and stocks suffer the same tax.

Answer 2

Stocks and mutual funds work pretty much the same way. In both cases, you can have short term gains or long term gains. Short term is for investments held less than a year - gains are taxed at the same rate as your other income. Long term gains, for investments held over a year, are taxed at a lower rate.

If you own a mutual fund that has capital gains for you to report on your return while you still own it, you need to keep track of the amount of the distribution that you paid tax on, since when you do sell, that becomes part of your basis and you don't pay tax on that same amount again since you already did pay.

If you're a trader, buying and selling quickly, or if you buy stocks that you won't want to hold for a year, then you'll be stuck paying short term capital gains tax.

Answer 3

Given your question and options available, I am assuming that your income is too high to qualify for a Roth IRA or tax-deductible IRA. If this is incorrect, go with the Roth or Tax deductible, it's a better option. If your purpose for the savings is retirement, and you plan on taking it out after age 59 1/2, I would indeed suggest the taxable/traditional IRA. You would defer the capital gains tax, and hopefully your tax bracket will be lower when you retire - if my assumption is right, your tax bracket is REALLY high now! The capital gains tax isn't going to stay at 15% long-term, it will go up somewhere along the way, and the IRA protects you from that increase. Plus, if your income drops below the income maximum for Roth IRA rollovers, you can roll your taxable IRA over into a Roth IRA tax-free! That could be a major bennie! However, if you are maxing out your 401(k) to the tune of 15k+/year, you may be pretty well set for retirement. If you want your cash earlier than 59 1/2, go with the taxable account. --- New response: Personally, I can see arguments either way. You could go with a taxable account. If you do this, you should be careful to invest only in stocks and funds that are tax-friendly, meaning that they don't trade much, don't distribute much in dividends, and don't distribute much in capital gains. This is a significant restriction in your investment choices. However, you get a big advantage in the fact that if you need the money before you are 59 1/2, you can have it. The IRA gives you the flexibility not to worry about how tax-advantaged your investments are, because it simply doesn't matter. It also gives you the benefit that if you have one year somewhere down the road when your taxable income is low, you can roll the whole thing over into a Roth IRA, which is a big benefit if you can pull it off. But, the big drawback is that you can't touch the money until you are 59 1/2. As for stocks vs. funds, the main thing is to have a sensible asset allocation across all of your retirement investment accounts. Since the bulk of your money is in the 401(k), I would put the IRA or taxable account money into asset classes you can't get with your 401(k) or asset classes where your 401(k) options suck. For example, if you want to put 10% of your portfolio into commodities funds, you probably can't do it in your 401(k), so do it in your other accounts. If your 401(k) fund has emerging markets funds that charge 3% per year fees, find one that charges less and buy it in your IRA. Lastly, if you like to play with stocks, and want to keep a small part of your portfolio aside for investing/speculating in individual stocks, you can do that in your IRA. In my case, my 401(k) really only has good investment options for large US firms and large international firms. All the other funds in the plan charge high fees. So, my 401(k) is all large US and international equity funds, and my IRAs handle the rest of the investment classes like bonds, emerging markets, small-cap stocks, and commodities.

Answer 4

For tax purposes the two are pretty much the same. Hold them for less than a year and you have short term gain, taxed at the same tax rates as your other income. Hold them over one year and you have long term gain which is taxed at 15% or your regular rate if it is smaller.

Answer 5

The rates are the same, supposedly. But, on the mutual fund, you may be double-taxed, or taxed on gains that you didn't participate in. The mutual fund may declare a "capital gains distribution" that you have to pay tax on. Then, later, when you redeem your fund, you have to pay tax on the gains in the NAV.