Do I Ihave to pay tax on profits I make in the stock market?
Question:
I may open a small separate mutual fund and I wonder what the tax will be. I am putting 5k into it and not planning to withdraw any money for 5-10 years.
Yes, you have to pay taxes each year on gains on your mutual funds, but not your IRA as you said.
yup, capital gains taxes. My mom got socked for over 10K for 2006 after selling off some of her portfolio that was under performing.
The tax you pay will depend on how well your fund does.
Yes you will have to pay taxes on the interest income when you remove the money from the IRA.
If you withdraw money from a standard mutual fund it's not taxed as income, because you pay taxes on the interest income every year. Interest income is taxed at 15% according to the IRS website.
Of course that assumes you're in the United States.
IRA is a tax deferred account.
Separate taxable investment accounts are taxed as capital gains or income is realized.
The most important tax information of mutual fund products that investors needs to be aware of is that tax is applied at the fund level, and then passed on to the investors of the fund. This means that the trading activities of the fund determine the tax liability, which is then shared on a pro-rated base among all the investors of the fund.
The effect is that even though you might not have engaged in any taxable transactions in some particular period, you might still be liable to pay your share of the fund’s tax if the fund has engaged in taxable transactions. In other words, if your fund went down 20% over the year, you could still be liable for taxes even though you lost money. If mutual fund is held in a taxable account, the individual investor typically don't know what the tax is until they get the bill.
Because of the taxable transactions of a mutual fund is at the discretion of the fund manager, and not the investor, most people only hold mutual fund products in taxed deferred accounts such as IRA or 401k’s, thus bypassing the tax issue altogether. Otherwise, mutual funds are considered extremely tax-inefficient investment vehicles when held in taxable accounts.
For taxable accounts, I use ETFs instead. Exchange Traded Funds often offer the same diversification benefits of mutual funds, but due to a particularly feature of the product (which is too complicated and pointless unless you work in finance), they are taxed and traded on the open market just like common stocks, i.e. I’m taxed only when I realize capital gains or receive dividend. Just like common stocks, almost all ETF products can be accessed from any brokerage account.
Some popular ETFs include the NASDAQ 100 (QQQQ) or SP500 index (SPY). A good resource is “ETFconnect.com”
ETF is part of a larger family of investment products know commonly as “open-ended funds” (not the same as “close-end funds”, which is a very different animal altogether). ETFconnect.com refers to true ETF as “Index Exchange-Traded Funds”
Yes, our government has decided that it has the right to take a piece of your investment gains, even though it puts up none of the money and takes none of the risks. Isn't that awesome?
You will have to pay taxes in the following 3 ways:
1) When your fund manager incurs a capital gain within the fund's portfolio because she sold some of the fund's stocks to buy different stocks. You have no control over this. You will pay a capital gains tax on these. However, "index funds" are passively managed and tend to trade much less, so you end up with less capital gains each year.
2) When the stocks or bonds within the fund pay dividends or interest. You pay taxes on these. You have no control over this. However, certain types of bonds (municipal bonds) have interest that is exempt from federal taxes.
3) When you sell your shares, you will pay a capital gains tax on any shares that are sold at a price higher than what you originally paid.
Long-term capital gains (1 year or more) and dividends from domestic stocks are taxed at 10% or 15%. Short-term capital gains (less than 1 year), interest from bonds, and dividends from REITs are taxed at your marginal tax bracket.
Your mutual fund company will send you a statement in January detailing all your fund's taxable events. It will tell you what numbers to stick in what boxes on your tax return. So, you don't have to be a tax expert to do this. However, when you eventually sell your funds, you capital gains tax (#3 on the list) might be tricky and you may want to consult a tax advisor that year.
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