A $750,000 Dividend Portfolio Can Leave You Owing About $9,000 More in Taxes Each Year. Here’s Why

Quick Read

• Ares Capital and Main Street Capital distribute ordinary-income dividends, which means a Roth account saves $2,930 and $1,670 a year, respectively, on $125,000 holdings.

• In a taxable account at the 24% bracket, this dividend portfolio sends about $9,000 of its $44,600 in annual payouts to the IRS.

• If that $9,000 is reinvested at 4%, the Roth advantage can grow to roughly $269,000 over 20 years.

Put $750,000 equally into six high-yield stocks and, at current prices, the portfolio produces about $44,600 in annual dividends. In a taxable account for someone in the 24% bracket, around $9,000 of that amount would go to taxes each year.

What Each Holding Adds to the Tax Load

Each position receives $125,000. Each yield is based on the forward annual distribution divided by the current share price. BDC and REIT payouts are taxed at the 24% ordinary rate, which applies to single filers above $105,700 of taxable income and to married couples filing jointly above $211,400. Qualified dividends are taxed at 15% under 26 U.S.C. § 1(h)(1)(C).

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ARCC, MAIN and O account for half the invested money, yet they generate $6,230 of the tax bill, or 69% of it. These three stocks stand to benefit the most from being held in a Roth.

Roth Account vs. Taxable Account: A $9,000 Annual Difference

Over 10 years, assuming no new contributions and no growth, the difference reaches $90,200. Qualified Roth distributions “shall not be includible in gross income” under 26 U.S.C. § 408A(d)(1), so the Roth outcome stays unchanged when the money is withdrawn.

Higher Brackets Mean a Bigger Tax Drag

Qualified dividends are taxed at 15% through the 32% bracket and at 20% in the 37% bracket.

Moving from the 22% bracket to the 37% bracket increases the annual cost of holding these stocks outside a Roth by about $4,800. Nearly all of that extra tax burden comes from the ordinary-income payers.

How $9,000 a Year Can Compound Into $268,700

Reinvest the annual $9,000 at a conservative 4%, which is below the 10-year Treasury yield of 4.95%. Under that assumption, the benefit grows to about $108,300 after 10 years and $268,700 after 20 years. Without compounding, the 20-year total is $180,500. These calculations assume no share-price appreciation. They illustrate the long-term drag of holding these positions outside a Roth in the 24% bracket, and the burden rises whenever a holding increases its dividend.

You can plug in your own bracket and reinvestment rate to run the numbers:

Three Moves to Consider Before the Next Tax Return

1. On Form 1099-DIV, separate ordinary dividends from qualified dividends. Multiply the ordinary amount by your marginal rate to estimate what your BDCs and REITs are really costing you in taxes.

2. If you own both a Roth and a taxable account, compare an asset-location swap: put ARCC, MAIN and O in the Roth, and keep qualified dividend payers such as MO, VZ and WMB in the taxable account, where the 15% rate already limits the tax bill.

3. If you have a traditional IRA, consider a staged Roth conversion, beginning with the ordinary-income payers. The lower-income years between your final paycheck and your first RMD are often the least expensive time to do it. Compare the one-time conversion tax with savings such as the $2,930 a year on a $125,000 ARCC position before concluding the upfront cost is too high.

Learn 7 Ways To Generate Income With A $1,000,000+ Portfolio

If you’ve saved more than $1,000,000, this guide is for you. The last thing you want in retirement is to run out of money; you want your assets to keep producing lasting income while you enjoy your life.

Now you can learn the strategies wealthy retirees use to fund their retirement with The Definitive Guide to Retirement Income from Fisher Investments. Download the guide today! (sponsor)