Macro Minute: Week of December 8, 2025
We have all heard that there are two certainties in this life, death and taxes. Let’s talk about the rosier of these two constants, taxes. From an investors’ perspective we want to earn the highest possible return while taking the appropriate amount of risk. The impact of taxes is One thing that is rarely talked about when discussing investment returns. The reason for that is because in the U.S. we have a tax system that makes everyone’s taxes individualized and complex. I always think about this funny tweet when it comes to taxes.
This is why investment returns can be misleading; it doesn’t matter how much money you make, it matters how much you keep. There are nuances that are very individualized, but in general returns are taxed in three ways: dividends, short-term capital gains, and long-term capital gains.
There are many people that really push dividend income, but I think it is the least desirable form of return because it is taxed at the highest possible rate. That is because ordinary dividend income is taxed at your regular tax rate, 10%-37%. There are qualified dividends that are taxed at the long-term tax rate, but most of the dividend income is at the ordinary income rate. Short-term capital gains are when you buy a security and sell it for a gain in less than a year. This is taxed as regular income also, 10%-37%. To me the highest form of return from a tax standpoint is long-term capital gains. This is when you buy a security and sell it for a gain after holding it for at least a year. This is taxed at 0%,15%, or 20% depending on your taxable income. For the majority of people, they pay 15% on long-term capital gains.
In addition to the type of return that is generated, the type of account can make a huge difference in your realized long-term return. Here there are three primary types of accounts: taxable, tax deferred, and tax-free. A taxable account is taxable every year based on the portfolio return mix of either dividend income, short-term gains, or long-term gains. A deferred account is a retirement account that is funded today for a taxable income reduction, but in retirement, withdrawals are taxable. In a deferred account it doesn’t matter if the returns are dividends or capital gains because the disbursements are taxable income at the personal tax rate. The last type of account is a tax-free retirement account. These are funded with after tax dollars today, but the disbursements are not taxed. Both deferred and tax-free accounts have different rules around funding limits and withdrawals, further complicating things.
As you can see, it can become complicated when thinking about after-tax returns. As one would expect from me, I would suggest a mix of all three types of accounts over time. A taxable account may appear to have the least favorable tax treatment, but if you are holding securities that are held long-term and generate long-term capital gains, the tax can be manageable. Taxable accounts also have the highest amount of flexibility from a withdrawal standpoint. Deferred accounts many times are eligible for employer matching contributions and can lower your current tax liability. Just realize that the tax liability is only being deferred to a later date, not abolished indefinitely. You must consider if your tax rate will be higher or lower in the future when you are forced to take withdrawals from that deferred account. The last is really the best from a long-term growth perspective. Tax-free accounts can be the most challenging to fund because of contribution limits, but the ability to allow the assets to grow indefinitely without having to be withdrawn or paying taxes on those future withdrawals make them very compelling.
All three account types have a role to play in helping you save and invest over your lifetime, just think about the impact of taxes on both your investment accounts and the way those investments deliver their returns. It can make a real difference to your investment outcomes.
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