How taxes on investments affect your returns

Taxes on investments directly impact your portfolio returns through the income you earn and the capital gains you generate when selling assets. Understanding how different investment vehicles and accounts are taxed is essential for minimizing your tax liability.

Each type of investment is subject to unique tax rules. In general, taxes can affect your investments in two ways: 

• You pay taxes on the income you receive from interest or dividends.
• You pay capital gains tax on the profit you make when you sell a capital asset, such as a stock or property. 

Your tax rate depends on your income bracket, the type of investment and, if you’re selling a capital asset, how long you’ve held it. Here’s a high-level look at how taxes apply to common investment vehicles and accounts. Because tax rules are complex, consider talking with a tax professional about your specific situation. 

Investment accounts vs. investment vehicles: What’s the difference?

Investment vehicles refer to what you invest in, while investment accounts refer to where you hold those assets. When evaluating how taxes on investments work, it helps to distinguish between the two.

• Investment vehicles are what you buy, such as stocks, bonds, mutual funds, ETFs or REITs. Each vehicle has its own tax characteristics, including how income and capital gains are treated.
• Investment accounts are where you hold those investments. Examples include taxable brokerage accounts, tax‑advantaged retirement accounts (like a 401(k) or traditional IRA) and tax‑free accounts (such as Roth IRAs and HSAs).

The same investment vehicle can be taxed differently depending on the type of account that holds it, which is why both play an important role in your overall tax strategy.

The table below summarizes how taxes apply to common investment vehicles and accounts, including when income, capital gains and withdrawals may be taxed. These factors can affect overall investment returns.

Fully taxable investment vehicles

Fully taxable investment vehicles do not offer special tax benefits, but they have no limits on how much you can invest. These options provide flexibility for building wealth.

Taxes on stocks

Dividends and capital gains from stocks are subject to taxes based on how long you hold the asset and your income bracket. Dividends from stocks are usually taxable, and the rate varies depending on the type of dividend:

• Nonqualified dividends are taxed at your ordinary income tax rate.
• Qualified dividends are taxed at a lower rate based on your taxable income and filing status. This rate caps at 20%.¹ Factors that determine whether a dividend is qualified are the time you’ve owned the stock, country of origin and the type of distribution received.

If you sell share for a profit, you pay capital gains tax. The capital gains rate varies based on how long you’ve held the stock:

• If you hold the stock for less than a year, you pay short-term capital gains at your ordinary income tax rate. 
• If you hold the stock for more than a year, you pay long-term capital gains. The rate is based on your income bracket and caps at 20%.²

Taxes on bonds

Interest earned on bonds is taxed as ordinary income, with the exception of municipal bonds (as discussed below).

Taxes on REITs

Real estate investment trust (REIT) distributions are taxed as ordinary income, while profits from selling shares are taxed as capital gains. REITs let you earn returns on bundled pools of real estate properties.

Taxes on mutual funds

Mutual funds are made up of different investment securities, such as stocks and bonds. The fund taxes dividends and capital gains based on how long it held the specific asset, rather than on how long you owned the mutual fund shares.

When you sell your shares, you pay taxes on any capital gains. If you hold mutual funds in retirement accounts, such as a 401(k) or IRA, or in a college savings account, such as a 529 plan, you only pay taxes on withdrawals. 

Taxes on ETFs

Exchange-traded funds (ETFs) act similarly to mutual funds but are generally more tax-efficient because distributions often only accrue on dividend or interest income. Like mutual funds, you pay capital gains tax when you sell your position.³

Fully taxable investment accounts

Fully taxable investment accounts offer flexibility without contribution limits or withdrawal rules. Some investors prefer the freedom these accounts provide for short-term financial goals like home remodels or major purchases.

Money market deposit accounts

Money market deposit accounts generate interest that is taxed as ordinary income. Money market accounts generally offer higher interest rates than savings accounts (though they may have a minimum balance requirement). They’re also FDIC-insured (at banks) or NCUA-insured (at credit unions) up to $250,000.

A financial institution invests your funds in short-term, low-risk, highly liquid assets to generate interest.

Tax-advantaged investment vehicles

Tax-advantaged investments are tax-exempt, tax-deferred or offer other specific tax benefits.

Municipal bond funds

Municipal bonds are generally exempt from federal taxes and may be exempt from state and local taxes. You can buy municipal bonds individually or as part of an ETF or mutual fund. Pooling multiple municipal bonds into a single fund allows you to invest in a variety of bonds.

If you live in the state where the bond was issued, you often avoid state and local taxes. However, if you buy bonds issued in another state, your home state may tax the interest income.⁴

Tax-advantaged investment accounts

Tax-advantaged accounts, also known as tax-deferred accounts, are funded with pre-tax dollars so you pay taxes when you withdraw the funds later in life.

401(k) accounts

A 401(k) account is an employer-sponsored retirement savings plan funded with pre-tax dollars. In many cases, your employer will match up to a certain percentage of your contribution. The 2026 contribution limit is $24,500. If you’re age 50 or older, you can contribute an additional amount each year.

Withdrawals made before age 59 1/2 may be subject to a penalty tax, while withdrawals made after age 59 ½ are taxed as ordinary income. You must take required minimum distributions (RMDs) beginning at age 73. Read more about 401(k) withdrawal rules.  

Traditional IRAs

A traditional IRA is a tax-advantaged account where contributions may be tax-deductible and withdrawals in retirement are taxed as ordinary income. In tax year 2026, you can contribute up to $7,500 into a traditional individual retirement account, or IRA. If you are 50 or older, you can contribute an additional $1,100.

You can take out money without a penalty after age 59 1/2, and you must start taking RMDs at age 73. Withdrawing funds early usually triggers a 10% penalty. Exceptions exist for first homes, higher education costs or specific medical costs.

Read more about IRA withdrawal rules.

403(b) accounts

A 403(b) account is a tax-advantaged retirement plan for public school and tax-exempt 501(c)(3) nonprofit organization employees. Similar rules and limitations to a 401(k) apply.

You contribute pre-tax dollars. The 2026 contribution limit is $24,500, and you can contribute an additional amount each year if you are 50 or older. You will face a 10% penalty for withdrawals before age 59 1/2, and you must begin taking RMDs at age 73.

Tax-free investment accounts

Tax-free investment accounts are funded with after-tax dollars, meaning you pay taxes upfront rather than when you withdraw funds or earn returns.

Roth 401(k) accounts

Roth 401(k) accounts are employer retirement plans funded with after-tax contributions, allowing for tax-free withdrawals in retirement. Plan participants can choose to have after-tax contributions directed to their employer accounts.

There is no income limit to participate in Roth 401(k) accounts. While contribution limits match traditional 401(k) plans, there are no RMD requirements with a Roth 401(k) under the current law.

Roth IRAs

You fund a Roth IRA with after-tax money, and qualified withdrawals are tax-free. The 2026 contribution limit is $7,500, plus $1,100 you’re over age 50. However, there are income eligibility restrictions for contributing to a Roth IRA.

You can withdraw your contributions at any time without penalty. After the age of 59 ½ you can also withdraw earnings tax-free if the account has been open for at least 5 years. There are no RMD requirements with a Roth IRA.

529 savings plan

A 529 plan helps you fund college expenses. You invest after-tax money and withdraw it tax-free for qualified education costs. These costs include tuition, fees, books, and housing. You can also apply up to $20,000 per year toward K-12 tuition.

Health savings accounts (HSAs)

A health savings account (HSA) lets you contribute pre-tax money and withdraw it tax-free for qualified medical expenses. Thes costs include doctor visits, health screenings and prescriptions. The 2026 contribution limit for individuals is $4,400 and $8,750 for families. Those over age 55 can contribute an additional $1,000 per year.

Principles for tax-aware investing

A balanced portfolio combines fully taxable, tax-advantaged and tax-free investment vehicles and accounts to help you manage your tax burden. Keep in mind the makeup of your portfolio affects your overall financial plan.

Principles to be aware of:

• Hold investments as long as possible. Assets held for more than a year benefit from lower long-term capital gains rates. As a rule of thumb, a long-term approach may help lower your tax bill.
• Not all investments are created equal. Even assets in the same class, like stocks, can impact your taxes differently.
• Plan your withdrawals. Withdrawing large sums from tax-advantaged accounts could push you into a higher tax bracket. Incorporating a tax diversification strategy and spreading withdrawals across your various account types could help you stay in a lower bracket.

These are not the only investment accounts or vehicles available, and tax rules change frequently. Talk with a financial or tax professional to design a strategy that fits your specific situation. 

Frequently asked questions

How are my investments taxed?

It depends on what you invest in, where you hold those investments and when you earn or realize returns. In general, taxes may apply to income like interest or dividends and to profits when you sell an investment.

Because each investment and account has its own tax rules, understanding how they work together can help you better evaluate the after‑tax impact on your investment returns.

What is the difference between tax-deferred and tax-free accounts?

Tax-deferred accounts allow pre-tax contributions but tax your withdrawals in retirement. Tax-free accounts require after-tax contributions today, but qualified withdrawals are tax-free later.

Do I have to pay taxes on unsold stocks?

You don’t pay capital gains taxes on stocks until you sell them. However, you must pay taxes on any dividends those stocks generate during the year.

Learn how our approach to wealth planning can help you see a full view of your financial picture.