IRA vs. 401(k): What’s the difference between an IRA and a 401k?

Individual retirement accounts (IRAs) share many characteristics of retirement plan accounts like 401(k) accounts or Thrift Savings Plan accounts, but differ in many other ways.

The main similarities? Tax-deferred growth possibilities, as both forms of accounts generally offer tax-deferred earnings from interest income, dividends, and capital gains. They also offer the potential to reduce your income tax burden, though in different ways.

They both offer the possibility of taking hardship distributions for items like unreimbursed medical expenses, medical insurance, disability, qualified college expenses, and first-time home purchases. Generally, hardship distributions are limited to the amount of your contributions or deferrals. Some distributions are taxed and typically also incur a 10% early-withdrawal penalty if taken prior to the age of 59½.

The subtle, but important, differences between IRAs and 401(k) accounts arise when answering the questions below.

  • Where do contributions come from and how are they handled from a tax standpoint?
  • How are early distributions treated?
  • When are federal taxes withheld automatically?
  • When do Required Minimum Distributions (RMDs) begin?

IRA vs 401(k) contributions.

Contributions to traditional IRAs may be tax deductible. Contributions to Roth IRAs are not deductible.

Contributions to workplace retirement plan accounts — with the exception of Roth 401(k)s — are typically taken from pre-tax dollars, money taken from your paycheck prior to it being taxed.

IRA vs 401(k) distributions.

Distributions from traditional IRAs are subject to specific requirements. Generally, a distribution taken before the age of 59½ is subject to a 10% early distribution penalty. The penalty no longer applies once you reach 59½. However, all distributions are taxed as ordinary income. In the case of a Roth IRA, distributions made before age 59½ are not taxed or penalized provided the amount withdrawn is smaller than what you contributed.  When you need money from your 401(k) or other retirement account — in a non-hardship situation — it must first pass through to an IRA (a rollover IRA) after you separate employment. At that point, it’s subject to normal terms of distributions from IRAs.

If you are remaining in your job, but would still like to access money in your 401(k) account, you may be able to borrow the needed funds.  Many 401(k) plans offer loan provisions.

Federal taxes.

When you move money from your retirement plan directly to an IRA or another qualified retirement plan — and the transfer is direct from one account custodian to another — your investments are not subject to federal taxes. If the transfer is indirect, your investments are subject to a 20% federal tax withholding.

Qualifying distributions from a contributory or rollover IRA are subject to federal and state taxes as ordinary income after you reach age 59½.

If your investments are held in a Roth IRA, distributions of income, capital gains, and dividends are not taxed if you’re 59½ and your account has been open five years. Also, until you reach that age, distributions are untaxed as long as they don’t exceed your contribution total.


In the year you reach age 70½, your investments are subject to required minimum distributions (RMDs) unless they’re in a Roth IRA. RMD rules apply to all employer-sponsored retirement plans as well as traditional IRAs and IRA-based plans like SEPs and SIMPLE IRAs. RMD rules do not apply to Roth IRAs while the owner is alive. The amount of your RMD is determined largely by three things: your age, life expectancy conversion tables from the IRS, and the combined balance of your investments in qualified investment accounts.

One final thing: while many employers offer matching contributions to their employees’ retirement plan accounts, they don’t make matching contributions to their employees’ IRAs.

Market Summary: February 2018

Volatility wakes up with a jolt.

Market volatility’s long nap ended abruptly in early February with 150% more days recording Standard & Poor’s 500 index movements of more than +/- 1% than in all of 2017. And although we saw the pattern of positive stock returns end, too, the S&P 500 finished the month up for the year.

What happened.

Early February marked the end of a long period of unusually low volatility in stock markets. Last month saw 12 days in which U.S. large-cap stocks (as measured by the S&P 500 index) moved by more than +/- 1%. Seven of these days were positive and five negative (including three big down days early in the month). By contrast, all of 2017 had only eight +/- 1% days. February also broke the pattern of positive stock returns as by Feb. 9, stocks at home and abroad were down sharply. While stocks recouped some of their losses during the rest of February, they still ended the month down. Large-cap stocks were down 3.69% for the month. Mid- and small-cap stocks were also down 4.43% and 3.87% respectively (S&P 400 and 600 indices).

International stocks fared slightly worse than domestic stocks. Developed markets fell 4.51% (MSCI EAFE Index) and emerging markets dropped 4.61% (MSCI Emerging Markets Index). Interest rates rose over the month, leading to a fall in bond prices with the Bloomberg Barclays Aggregate index down 0.95%.

Looking at last month’s market declines from a slightly longer perspective, the S&P 500 is still up for the year with a positive return of 1.83%. Developed-market stocks also are positive for the year, with the MSCI EAFE Index up 0.28%. Bonds, however, are down 2.09% since Jan. 1.

Why it happened.

It’s impossible to say precisely why market volatility kicked up early in the month. Explanations include the indirect effect of relatively obscure financial instruments that bet on market volatility, and worries that continued strong economic performance might lead the Federal Reserve (Fed) to raise interest rates faster than expected.

It may be more useful to look at some of the actual concrete events in February. First, earnings season (the period in which companies report their results for the previous quarter) closed strongly. Over the season, 77% of S&P 500 firms reported higher sales than analysts expected (FactSet). Second, wages grew more than anticipated. Together, these point to a strong economy, which is a good thing. Why, then, did markets appear to react negatively?

Higher wage growth increases fears that inflation may rise, which in turn could lead the Fed to raise interest rates to prevent the economy from overheating. We also have a new Fed chair, Jerome Powell, and it’s not yet clear how “hawkish” or inclined to raise rates he is. Trying to get a read on him, market participants paid close attention to his House testimony near the end of the month. After he spoke, stock markets fell and interest rates rose, suggesting he is viewed as somewhat more hawkish on inflation than his predecessor, Janet Yellen. By the end of February, the yield on 10-year bonds (the interest rate that the government needs to pay to borrow for that period) had risen to 2.87% from 2.72% at the end of January. One-month yields rose from 1.43% to 1.5%. These increases reflect expectations of future interest rates.

Looking overseas, foreign stocks faced a headwind as the dollar rose by 1.71% (measured by the DXY Index). This is a change in direction from a long decline that’s lasted since December 2016. A stronger dollar hurts the returns of foreign assets for U.S. investors.

What it means for you.

After a long period of smooth sailing, the sudden return of market volatility may be unnerving. It’s important, however, to stay focused on your goals and put recent events into a longer-term perspective. We discuss how to cope with volatility in this month’s sidebar. Your portfolio probably will have declined this month, since all major asset classes fell. Bonds, however, fell by less than stocks, and lower-risk portfolios allocate more to bonds. This means the closer you are to retirement or the lower your risk preference, the less your portfolio will probably have fallen.

If you decided to take more risk or are a long way from retirement, your portfolio will have a greater allocation to stocks. Stocks offer greater expected returns over a long horizon, and so your portfolio will likely have fallen more this month. At Financial Engines, we build portfolios to meet your unique situation and preferences. If you have concerns about the level of risk you’re taking, we encourage you to call one of our advisors. We’re here to help.

Retirement fundamentals: Why you shouldn’t trust history.

For a more in-depth read, check out The Intelligent Portfolio by Christopher L. Jones, Financial Engines’ Chief Investment Officer.

“History is more or less bunk.”  — Henry Ford (1863-1947)

One of the most common mistakes investors make is basing investing decisions on history and past performance. It’s not entirely their fault. Human beings are wired to believe that the past will repeat itself. Some marketers of financial products know this and spend huge sums to reinforce our natural tendencies. They highlight stellar fund performance records to get us to invest in what appears to be a sure thing at first glance.

There’s only one catch: a strong historical investing track record doesn’t tell you much about future expected returns.

In general, future returns have very little to do with how well a fund did in the past. The past rarely repeats itself.

Historical data can be useful for understanding risks and how different assets move together, but it doesn’t provide much information about the level of returns we can expect in the future. Investment returns in one period are usually not correlated with returns in a subsequent period. Sometimes a fund that is doing well will continue to do well in the future, but just as often, it may not. You should never assume that past performance is indicative of how a fund may perform in the future.

Moreover, there are many future possibilities that have never happened before. Just because we haven’t experienced something yet, doesn’t mean it can’t happen. Your investment decisions should be based on what’s possible, not just on what’s happened in the past.

The future is uncertain.

The truth is that there’s a great deal of uncertainty about the investment returns we can expect to see in the future. How the stock market behaved in the past could look nothing like what we might experience in the future.

Once again, it pays to be a skeptical investor. You know that tiny legal copy at the bottom of every investment product (“past performance is no guarantee of future returns”)? It’s easy to skip over it because we see it so often, but it actually means something and it’s absolutely true. Be careful about extrapolating from the past to predict the future of your investments.

However, there are things that are very predictable. For instance, investment fees. You might not see the same fund performance in the future that you saw previously, but you can bet that you will be paying similar fund expenses as last year. Investment performance will vary from time period to time period, but the impact of fees is very predictable. That’s why paying attention to expenses is so important.

To get a better sense of what your portfolio could do, you need sophisticated analytics. They can help you determine the investment exposures of a fund, how well it did relative to an appropriate benchmark and the range of possible outcomes it might deliver in the future.  Luckily, you don’t have to do all of that work yourself. Financial Engines has built its business around helping investors like you plan for their future retirement.







6 investing questions you may be too embarrassed to ask.

advisor answering client investment questions

Have you ever felt hesitant to ask your investment advisor (or anyone else, for that matter) a question about investing or retirement planning? When it comes to these complicated topics, there are truly no stupid — or overly simple — questions. Though you might feel embarrassed asking a question if you think you “should” already know the answer, you’re better off getting the information than continuing to live in the dark about something so important and personal. After all, it’s your money … don’t you want to be confident about what you’re doing with it?

We get questions every day from people who admit to being embarrassed about their perceived lack of knowledge. Let’s tackle some of them here.

1. What is a mutual fund?

A mutual fund is a “basket” of investments, usually stocks and/or bonds. When all of the investments are bundled together into a fund, investors can purchase shares in the mutual fund. Having mutual fund shares means an investor owns part of the investment basket — regardless of which underlying investments are bought or sold. Mutual funds are often preferable to single stocks and/or bonds because of their diversification (the practice of purchasing a wider variety of investments to lessen a portfolio’s overall risk), convenience and lower costs.

2. If my mutual fund is losing money, should I stop investing in it?

Thanks to the nonstop news cycle, we can see what’s happening with the market on a minute-by-minute basis. However, always knowing what’s going on with the market or your specific investments isn’t necessarily a good thing. At Financial Engines, we emphasize a sound, long-term investing strategy over knee-jerk reactions to short-term market performance. This means that if you’ve done your research and thoroughly assessed the fund and its fit with your portfolio, it’s probably worth sticking with the investment even if it’s losing money in the short term. But, if you’re losing money from a mutual fund you picked randomly, you might want to look at other options.

At least annually, you should revisit your investment goals and re-evaluate the level of risk you’re comfortable with. You should also do this whenever you experience a major life event, such as marriage or the birth of a child, that may affect your retirement and investing goals (and your choice of investments as a result).

3. What is a bond?

Bonds are commonly referred to as fixed-income securities. They’re often used by investors to help diversify a portfolio and manage its risk. A stock is an ownership share in a company, whereas a bond (or debt obligation) is a claim on the assets of a company. There is generally less risk in owning bonds than in owning stocks. Bonds tend to provide a higher and steadier income than a money market or savings account; however, stocks have historically seen higher returns over longer periods.

4. What is an index fund?

An index fund is a type of mutual fund that matches or tracks the components of a market index, like the S&P 500 Index or Dow Jones Industrial Average. It can provide exposure to a large number of companies within a specific market segment. Typically, index funds have low management fees and returns similar to those of the indices they track. The term “index investing” is often used interchangeably with “passive investing.”  With index investing, if the index rises 10%, the fund value should grow about 10%; if the index falls 10%; the fund should drop around 10%.

5. What is an expense ratio?

An expense ratio is a measure of what it costs a fund company to manage a mutual fund. Each mutual fund will have its own expense ratio shown as a percentage of the fund’s assets. On an individual investor level, the expense ratio is a fee for management costs paid for out of your investment in the fund. Higher expenses matter because they will reduce your returns.

Expense ratio = Total expenses to run the mutual fund / Total dollars under management

When you look at the total returns of a mutual fund, those numbers are always net of all expenses — in other words, they reflect performance after all fees have been taken out.

6. When I retire, is there a minimum amount I am obliged to withdraw from my retirement accounts per year?

A Required Minimum Distribution (RMD) is the minimum amount anyone over the age of 70½ is required to withdraw annually from their retirement accounts. For employer-sponsored retirement plans, such as 401(k)s and 403(b)s, RMDs can sometimes (depending on plan rules) be delayed until you retire. For traditional Individual Retirement Accounts (IRAs), you must begin taking RMDs once you turn 70½, regardless of whether you’re still working.  However, RMD rules don’t apply to Roth IRAs while the account owner is alive.

Your plan custodian or administrator can usually help calculate your RMD, but it’s ultimately up to you to ensure that you withdraw the correct amount each year by the deadline (typically Dec. 31) — otherwise, the amount not withdrawn is taxed at 50%. The U.S. Securities and Exchange Commission offers a calculator at you can use to help calculate your RMD or contact an investment advisor for assistance.

Are you distracted by the bulls and bears?

Woman researching market conditions

No two roads to retirement are alike. Your journey will look different from that of your friends and colleagues based on a near-infinite number of factors, such as income, savings rate, personal retirement goals — the list goes on.

However, there are some common scenarios that, regardless of the journey, most investors and retirement planners will encounter at some point. And while it’s easy to let your worries take hold when faced with one of these seeming conundrums, letting your emotions get the best of you could do more than just cause unneeded stress. If you let your emotions push or keep you out of the market in such times, it could hit you where it hurts the most: your bottom line.

We’ve said it before, but it bears repeating: The best way to achieve your investing and retirement goals is to develop a long-term plan — and then stick to it. Sure, adjustments may be necessary along the way, but your personal circumstances and not the movements of the market should drive any changes you make.

Without a long-term approach, it’ll be too easy for you to get trapped by one of these common market scenarios:

“The market is at a high and I’ve missed my chance.”

Should you find yourself trying to pick the “perfect time” to get back in the market, forget about it — there’s no such thing. Rather, get back in gradually by determining an amount you’re comfortable investing and combining it with a schedule that works for you. If you want to invest $10,000, that might mean investing $5,000 now and another $2,500 every 30 days, or $5,000 now and another $500 each month, until you’ve invested the entire sum. This strategy is an example of dollar-cost averaging, whereby you put a set amount of money each month into your investment and retirement accounts. This tried-and-true method works because you’re investing an amount you’re comfortable with, and you don’t need to worry about making the right decision at the perfect time.

“The market is too volatile right now; sitting out is safer.”

If you think getting out of the stock market to avoid volatility is the better way to go, consider the cost of being on the sidelines for just a few days. If you’d invested $10,000 on Jan. 1, 1989, and stayed invested, that $10,000 would have been worth $180,926 on Dec. 31, 2017 — up +10.5%1. However, had you missed only the market’s 30 best days over that period, your original investment would have grown just +4.6% to $37,1692.

“The market has dropped / I fear a pullback; sitting out is safer.”

Not to worry — market pullbacks, which typically represent a 5%–9% decline, are normal and can even be a sign of a healthy market. Take the S&P 500 index (and its predecessor) going back to 1928. On average, you’ll see the stock market drops -5% five times per year, -10% twice a year, and -15% once a year3. If you get out of the market during a downturn, you’re locking in your losses and making them permanent — but a downturn can actually present a good opportunity to buy at lower prices.

It’s best to take emotion out of your investing strategy to avoid getting sidelined by one of these market scenario traps. And how do you do this? By getting a plan.

1, 2 As represented by total returns on the S&P 500 Index from Jan. 1, 1989, to Dec. 31, 2017. Index returns are provided as a benchmark and are not illustrative of any particular investment. An investment cannot be made in an index.

3 S&P Dow Jones Indices LLC.

6 tips for building a tax-efficient investment strategy.

online money calculator investment receipts

You’re likely to hear a lot of talk about “tax-efficient investing” — but what exactly does that mean?

Tax-efficient investing means using strategies that can help with after-tax wealth accumulation, instead of solely trying to minimize taxes.

In other words, it’s about what you keep after taxes. You can pay no taxes by having no money, but that is neither practical nor ideal.

Taxes matter when it comes to evaluating the overall performance of your investments. They also add a layer of complexity to investing because your investment and tax strategies should be tailored to your personal circumstances. Generalities and rules of thumb can only do so much when there’s a lot to consider: income tax bracket, state of residence, marital status, how often a mutual fund distributes capital gains, your investment style, the types of accounts in your portfolio, etc.

In his book The Intelligent Portfolio, Christopher Jones, Financial Engines’ chief investment officer, outlines six key principles for pursuing a tax-efficient investment strategy:

1. Reduce the impact of taxes on after-tax returns by paying lower tax rates and deferring taxes into the future when possible.

2. Avoid paying high taxes on taxable distributions when possible.

3. Be smart about holding different kinds of assets. For example, equity funds are generally more tax-efficient than bond funds (except municipal bonds).

4. Hold assets that are less tax-efficient in a tax-deferred account (such as an IRA or 401(k)) and assets that are more tax-efficient in a taxable account (like a brokerage account).

5. Avoid equity mutual funds with large short-term capital gains distributions. Equity funds with high turnover (more than 100% per year) are particularly likely to distribute short-term capital gains. Index funds are typically more tax-efficient.

6. If you are in a high-income tax bracket, consider municipal bonds for your fixed income holdings in taxable accounts. Never hold municipal bonds in a tax-deferred account like an IRA, and low-income investors should generally avoid municipal bonds.

It’s no secret that this is complex information requiring a lot of coordination. Investors can put tax strategies in place on their own. However, with so many variables to think about, particularly if a large portion of your investable assets are held in taxable accounts, it often makes sense to consult a qualified investment advisor or tax expert.

Historically, that level of personal service was commonly reserved for high net worth individuals — but today’s technology and new services have opened the door for investors from all income ranges to build a tax-efficient investment strategy with professional help. Financial Engines offers investment advice that can help many of our clients take full advantage of opportunities designed to help save money and accumulate wealth over the long-term.

Taxes are something on most people’s mind throughout the year. Having an understanding of how your accounts will be taxed can help you put a strategy in place that keeps your money working for you.


This post is based on Chapter 11 from the book The Intelligent Portfolio, by Christopher Jones, Financial Engines’ chief investment officer. While the content has been revised for the purposes of this blog, the ideas, information and some language remain intact.
Jones, C. L. (2008). The Intelligent Portfolio. Hoboken, New Jersey: Wiley & Sons, Inc.
©2018 Financial Engines, Inc. All rights reserved. Financial Engines® is a registered trademark of Financial Engines, Inc. All advisory services are provided by Financial Engines Advisors L.L.C. or its affiliates. Financial Engines does not guarantee results and past performance is no guarantee of future results.
The information provided is general in nature, is for informational purposes only, and should not be construed as legal or tax advice. Financial Engines does not provide legal or tax advice. Financial Engines cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Financial Engines makes no warranties with regard to such information or results obtained by its use. Financial Engines disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

What you need to know about tax-advantaged savings accounts.

Taxes can take a big bite out of your total investment returns. So when making your investment decisions, you’ll want to look for ways to help maximize tax benefits in addition to the usual considerations of potential investment risks and returns.

The first thing to understand is the difference between tax-deferred, after-tax and taxable savings accounts.

Tax-deferred savings accounts, such as a traditional 401(k) or IRA, allow you to delay paying taxes until a future date. Instead of paying taxes when you contribute to these accounts, you pay taxes when you withdraw money from them, which could be 30 or 40 years down the road. Tax-deferred accounts have many benefits, including:

  • The dollars you invest may reduce your current taxes. So money you would have paid in taxes gets invested for your future instead.
  • You may be in a lower tax bracket when you withdraw the funds.
  • Your investment earnings aren’t taxed when they’re reinvested, which may help your account grow faster.

After-tax retirement accounts, such as a Roth IRA or Roth 401(k), help you create tax-free retirement income. You fund these accounts with dollars that have already been taxed. Your money then grows and can be taken out completely tax-free as long as you meet certain qualifications.1

With taxable accounts, such as bank savings accounts, certificates of deposit (CDs), and brokerage accounts, you have to pay taxes on interest and investment earnings each year. Like a Roth account, the money you put into these accounts has already been taxed.

Tax-advantaged savings accounts for retirement.

One of the best ways to save money for retirement is to use tax-advantaged (i.e., tax-deferred or tax-free) savings accounts.

  • Traditional IRA Anyone under age 70½ who earns income (or who is married to someone with earned income) can contribute up to $5,500 to an IRA in 2018. If you’re age 50 or older, you can contribute up to $6,500 in 2018. Depending on certain factors, you may be able to deduct IRA contributions to reduce current taxes. Investment earnings grow tax deferred and you’ll owe income taxes when you take withdrawals.2 Given that these rules can be complicated, it can help to consult a tax advisor.
  • Roth IRA Only people with income below certain limits can contribute to a Roth IRA. Contributions are made with after-tax dollars so there is no current tax deduction. Over time, investment earnings grow and qualified withdrawals are tax-free.3 Contribution limits are the same as traditional IRAs. If you contribute to both types of IRAs, the combined contributions cannot be more than $5,500 (or $6,500 for those age 50 and older) in 2018.
  • Employer-sponsored plans (401(k), 403(b), 457 plans) — Contributions to these plans can help reduce your current taxes. You can contribute up to $18,500 in 2018 if you’re under 50 or up to $24,500 if you’re over 50. Note, however, that both contribution limits are subject to plan rules. Investment earnings grow tax-deferred and you’ll owe taxes when you take withdrawals.4 Some employer plans also offer a Roth option, allowing you to build a source of tax-free income with the flexibility of higher contribution limits than a Roth IRA.

Tax-advantaged savings accounts for college.

  • 529 plans — College savings plans and prepaid tuition plans are tax-deferred ways to save for college. Money can be withdrawn tax-free if used for qualified education expenses. The plans are open to anyone regardless of income level. Contribution limits are high—typically over $300,000—but vary by plan.5
  • Coverdell education savings accounts — These accounts are available only to people with incomes below certain limits. If you qualify, you can contribute up to $2,000 a year per child. Contributions grow tax-deferred and withdrawals are tax free if used for qualified education expenses. Typically, balances in this account must be disbursed by the time the beneficiary is 30 years old or may be given to another family member below the age of 30.

You shouldn’t make investing decisions based only on tax considerations. But when you put your money into tax-advantaged accounts, it may allow you to keep more dollars in your own pocket and put fewer in Uncle Sam’s.


Part of this content has been contributed by Broadridge Investor Communication Solutions, Inc.
1, 3 To qualify for tax-free status, Roth funds must have been held in the account for at least 5 years and withdrawals must be made after age 59½ or after becoming disabled.
2, 4 Withdrawals before age 59½ may be subject to a 10% federal income tax penalty unless an exception applies.
5 Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing consider whether your state offers a 529 plan that provides residents with favorable state tax benefits. The availability of tax and other benefits may be conditioned on meeting certain requirements. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. For withdrawals not used for qualified higher-education expenses, earnings may be subject to taxation as ordinary income and possibly a 10% federal income tax penalty.

Taxes and investing: What you need to know.

While taxes may be unavoidable, understanding how they work can help you minimize them, or at least help you get the most bang for your buck. You’re probably already pretty familiar with sales tax and taxes on your salary, so let’s review what you need to know about how taxes apply to your investment returns.

Capital gains.

Capital gains taxes are one of two basic types of taxes on investment returns. You’ll pay capital gains taxes when you make a profit from selling an asset such as a stock, bond or even a house. There are two types of capital gains:

  • Short-term capital gains: Earnings on assets held less than one year are considered short-term capital gains and are treated the same as ordinary income. Like your income, short-term capital gains are taxed at the marginal tax rate, which corresponds to your tax bracket for the year. The more you make, the higher your marginal tax rate is. Short-term capital gains taxes are usually higher than other tax rates (generally greater than 22% in 2018, depending on your income level).
  • Long-term capital gains: If you hold your assets for more than one year, long-term capital gains taxes apply to any profits you make when you sell. These gains are taxed at a lower rate than short-term capital gains (usually 0% or 15% in 2018, depending on your income level).1

Keep in mind that capital gains don’t apply to investment income in retirement plans. Distributions you take from a 401(k) or traditional IRA are taxed as regular income, and aren’t subject to capital gains.

Dividends and income.

Taxes on capital gains are not the only taxes investors face. Dividends and income are also taxed.

  • Qualified dividends: If you’re invested in stocks, you may receive dividend payments. A qualified dividend is a dividend payment you receive on stocks you’ve owned for a specific holding period (usually at least 60 days). These are generally taxed at the more advantageous long-term capital gains rate. Dividend payments that don’t meet the holding period requirement are considered “unqualified,” and are taxed at your marginal rate.
  • Interest income: Interest income includes payments from bonds and the money you earn from interest-bearing accounts, such as a money market account. Like short-term capital gains, interest income is taxed at the higher marginal tax rate.

Special considerations for capital gains.

While you may not like paying taxes on your investment earnings, keep in mind that it’s a two-way street: While the government shares in your profits, it also shares in your losses. Say that one year you had $5,000 in gains in one investment, but also had losses of $10,000 in another. This puts you $5,000 in the hole. You can currently declare up to $3,000 each year in capital losses to reduce your taxable income for the year. Losses greater than that (so, the remaining $2,000 in our example) can carry over to the next year.2

The government also offers a special capital gains exclusion when you sell your main home. This allows you to exclude up to $250,000 in capital gains from the sale if you’re single, or up to $500,000 if you’re married. There are some additional considerations, however. First, you have to pass the “ownership and use” test to show that the property was your primary residence. To pass, you must have owned and lived in the house for at least two of the past five years. You also can’t have excluded gains from the sale of a different home within the previous two years.3 The rules around this and other capital loss write-offs are detailed, so read up and be clear on what you can and can’t do before moving forward.

Tax rates on investment returns can have a big impact on your bottom line, so it’s important to understand how the timing of selling your assets can affect your tax liability. Make sure you understand the tax implications before you make a move. After all, the less money you fork over to the government, the more you’ll get to keep for yourself.


This post is based on Chapter 11 from the book, The Intelligent Portfolio, by Christopher Jones, Financial Engines’ chief investment officer. The content has been revised for the purposes of this blog.
The information provided is general in nature, is for informational purposes only, and should not be construed as legal or tax advice. Financial Engines does not provide legal or tax advice. Financial Engines cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Financial Engines makes no warranties with regard to such information or results obtained by its use. Financial Engines disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
1 Frankel, M. (December 22, 2017). Your Guide to Capital Gains Taxes in 2018. The Motley Fool. Retrieved January 23, 2018, from
2 How Long Do Capital Gains and Losses Carry Forward? The Motley Fool. Retrieved August 3, 2017, from
3 Topic 702 – Sale of Your Home. Internal Revenue Service. Retrieved January 23, 2018, from

Avoiding charity scams.

There are only a couple of weeks left in this holiday season and for all of the consuming and buying that’s going on, there’s also the important tradition of giving. December is the time of year that charitable giving reaches its peak — of the billions of dollars donated annually, 12% happens during the last three days of the year.1 In fact, Dec. 31 is the single biggest day for online donations.2 There are thousands of groups you could donate to, but sadly, there are some that are more prone to scamming you out of your money than doing any real good. Fortunately, there are a few easy ways to help determine who’s naughty and nice — and make sure your money is going to the right place.

Beware of sound-alike names.

As an example, there are two groups that focus on helping children — the Children’s Charity Fund and the Children’s Defense Fund. They sound alike, but there is a big difference in their credibility — according to Charity Navigator, an organization that investigates and reviews charities, Children’s Charity Fund has a rating of zero stars while Children’s Defense Fund has a rating of four stars.

The same warning applies to scammer emails. You might receive a message asking for a donation that includes a web address that’s just one or two letters away from a real charity’s name — for example, instead of

Know who’s benefiting.

Some charities spend significantly more on salaries and fundraising events than they actually spend on their intended recipients. As a rule of thumb, at least 75% of the money an organization brings in should make it to their programs and services. Before you write a check or donate online, always look for the charity’s mission statement as well as their financial statement on their website. If you can’t find any financial information, that’s a big red flag and you should think twice before donating.

Use charity reviewers.

Third-party organizations can be helpful when it comes to evaluating charities. One of the most-respected is Charity Navigator — they rate almost 8,000 of the largest charities in the U.S. and provide information on those charities’ ratings, budgets, tax-exempt status, and IRS forms. They’ve placed almost 200 charities on their warning list and they always have a top ten list of the most over-paid charities in the nation. You can visit their website at

Another resource is your city’s Better Business Bureau (BBB). Each year, the BBB provides its communities with tools that tie back to its Wise Giving Alliance and are designed to protect consumers. You can find more information about the BBB’s charity reviews at

Charitable giving is an important and rewarding part of the season, so don’t get swindled by any Scrooges in disguise — do your due diligence and make sure your money goes where it’s most-deserved!


1Charity Navigator. (2014). Online Giving Statistics. Retrieved December 1, 2016, from
2MobileCause. (2016, January 21). Mobile Engagement Works. Retrieved December 1, 2016, from
This report contains references and links to Charity Navigator and, websites not owned or operated by Financial Engines. Financial Engines provides this resource solely as a convenience. The reference and appearance of the Charity Navigator or websites do not imply endorsement by Financial Engines, nor is Financial Engines responsible for its content. While Financial Engines believes the information is accurate and reliable, we are not responsible for its accuracy. 


Putting your year-end bonus to work for you.

If you’re one of the lucky ones who receives a year-end bonus, you’re likely thinking about how to spend it. Vacation? Shopping spree? It’s hard to fight the urge to splurge if you don’t have a plan for the money you’ve worked so hard for this year. Here are some ways you can make your bonus work for you now — and for your financial future.

Pay off your credit card debt.

High-interest debt can be financially crippling and getting rid of it as soon as possible is one of the most beneficial financial moves you can make. The average credit card variable interest rate was 16.61% as of Dec. 13, 20171 — and payments on interest alone can add up fast. If you can reduce what you owe now, you’ll have more money later. Just think about what you might be able to do in the future with that extra cash.

Invest in yourself.

You’ve worked hard for your year-end bonus and you should reward yourself. But instead of a new luxury item, how about learning a new skill? It may not be flashy, but it can help you grow personally and professionally, boost your value to your employer and potentially increase your future bonus potential.

Create an emergency fund.

Life is tough enough without having to pay for unplanned home repairs and medical emergencies. That’s not news to the more than 55% of employees nationwide who are worried they won’t have enough money available when the unexpected occurs.2 An emergency fund can help. Why not use some of your year-end bonus to create one and save yourself some anxiety later?

Pay it forward.

Research suggests that charitable giving can positively affect health and happiness — and in addition, it could also reduce your taxes when you report your contributions on your itemized return.3

A year-end bonus can be a gift that keeps giving, but only if you make the most of it. Call us if you have questions about any of these approaches. We’re here to help you make the most of your future with a financial plan that can help you reach your goals.


Current Credit Card Interest Rates. Bankrate. Retrieved December 18, 2017, from
2 (April 2016) 2016 Employee Financial Wellness Survey. PWC. Retrieved December 14, 2016, from
3 (15 November 2016). Wanna Give? This Is Your Brain on a ‘Helper’s High.’ Cleveland Clinic. Retrieved December 14, 2016, from