Investing in stocks is a great way to grow wealth over time. And you can make money with stocks in more ways than one.
First, if you load up your brokerage account with quality stocks and hold your shares for many years, there's a good chance they'll appreciate in value, setting you up to sell them at a profit. But you can also make money by investing in stocks that pay dividends.
How dividends work
When a company pays dividends, what it's doing is sharing some of its profit with shareholders rather than investing all of that money back into the business. Some people like the idea of dividend-paying stocks because they get to collect payments on a regular basis, usually every quarter.
To be clear, companies are not required to pay dividends. And it's possible for a company to pay one consistently for years and then stop that practice. Companies can also change their dividends by increasing or decreasing them.
What you can do with your dividends
When dividends land in your brokerage account, you have two options. You could reinvest them so they're able to help you grow wealth, or you can cash them out and use that money as you please.
You should know that there's no penalty for taking your dividend cash and running with it, so if that's the route you wish to take, go for it. In fact, some retirees have a strategy of holding dividend stocks and cashing out their dividends regularly to use as income to cover their living expenses. And cashing out your dividends won't make a difference from a tax perspective, either.
When cashing out makes sense
Maybe money has gotten tight in your world, but you don't want to liquidate your investments or raid your savings account. In that situation, cashing out your dividends would be a perfectly reasonable thing to do. And it won't hurt you from a tax perspective compared to reinvesting that money.
Dividends are generally taxed at a more favorable rate than ordinary income. If you're single earning up to $40,400, you actually fall into the 0% tax bracket for taxes on qualified dividends (most dividend payments fall into this category). And if you're single with an income of $40,401 to $445,850, your tax rate on dividend income is 15%.
But those taxes will apply whether you reinvest your dividends or not. So don't assume that cashing out will hurt you tax-wise.
The one way you might lose out
Cashing out your dividends could make sense. But remember, in doing so, you miss out on the chance to reinvest that money and grow it into a larger sum.
Cashing out $40 in dividend payments to cover a bill may not seem like a big deal. But over the past 50 years, the stock market's average return, as measured by the S&P 500, has been 10% before inflation. So if you were to reinvest $40 at a 10% return over 40 years, you'd grow it into about $1,800.
But still, if you have your reasons for cashing out your dividends, then so be it. And you could always cash out those dividends now, but make a plan to begin reinvesting them once your circ*mstances change.
Most brokerage accounts will actually let you set up an automatic dividend reinvestment plan if you so choose. That way, you won't even have to think about it.
Alert: our top-rated cash back card now has 0% intro APR until 2025
This credit card is not just good – it’s so exceptional that our experts use it personally. It features a lengthy 0% intro APR period, a cash back rate of up to 5%, and all somehow for no annual fee! Click here to read our full review for free and apply in just 2 minutes.
FAQs
In that situation, cashing out your dividends would be a perfectly reasonable thing to do. And it won't hurt you from a tax perspective compared to reinvesting that money. Dividends are generally taxed at a more favorable rate than ordinary income.
What happens when dividends are paid in cash? ›
Dividends can be paid out in cash, by check or electronic transfer, or in stock, with the company distributing more shares to the investor. Cash dividends provide investors income, but come with tax consequences; they also cause the company's share price to drop.
Is it better to cash out dividends? ›
Cashing out instead will preclude you from multiplying your investment. It May Take Longer To Achieve Long-Term Financial Goals: Dividend reinvestment leads to compounded growth. This makes it easier (and faster) to achieve your long-term financial goals versus keeping cash in a savings account.
Can you live off dividends of 1 million dollars? ›
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
Are dividends taxable when cashed out? ›
These stock dividends are not taxable when they are received. Rather, investors pay taxes when they sell their stock. If the investor does have the option of taking cash and stock but chooses the former, they are taxed accordingly.
Do you pay taxes on cash dividends? ›
Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%. IRS form 1099-DIV helps taxpayers to accurately report dividend income.
What happens if I withdraw my dividends? ›
The dividends you receive in your brokerage account can be cashed out or reinvested. When you cash out your dividends, you get more money to use as you please, but you lose the chance to grow it into a larger sum. Whether you cash out dividends or reinvest them, the tax implications are the same.
How do I avoid paying taxes on reinvested dividends? ›
Reinvested dividends may be treated in different ways, however. Qualified dividends get taxed as capital gains, while non-qualified dividends get taxed as ordinary income. You can avoid paying taxes on reinvested dividends in the year you earn them by holding dividend stocks in a tax-deferred retirement plan.
What is the best thing to do with dividends? ›
If you reinvest dividends, you can supercharge your long-term returns because of the power of compounding. Your dividends buy more shares, which increases your dividend the next time, which lets you buy even more shares, and so on.
How much do I need to invest to make $1 000 a month in dividends? ›
In a market that generates a 2% annual yield, you would need to invest $600,000 up front in order to reliably generate $12,000 per year (or $1,000 per month) in dividend payments. How Can You Make $1,000 Per Month In Dividends? Here are the steps you can take to build yourself a sufficient dividend portfolio.
This number has been cited so often that investors may feel as if they're failing if they don't reach it. But that shouldn't be the case. In fact, statistically, just 10% of Americans have saved $1 million or more for retirement. Don't feel like a failure if your nest egg isn't quite up to the seven-figure level.
Can I retire at 60 with $1 million? ›
It's definitely possible, but there are several factors to consider—including cost of living, the taxes you'll owe on your withdrawals, and how you want to live in retirement—when thinking about how much money you'll need to retire in the future.
How much money do I need to invest to make $4000 a month? ›
Making $4,000 a month based on your investments alone is not a small feat. For example, if you have an investment or combination of investments with a 9.5% yield, you would have to invest $500,000 or more potentially. This is a high amount, but could almost guarantee you a $4,000 monthly dividend income.
How much money do I need to invest to make $5000 a month? ›
To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.
How much do I need to invest to make $300 a month in dividends? ›
However, this isn't always the case. If you're looking to generate $300 in super safe monthly dividend income (note the emphasis on "monthly" income), simply invest $43,000, split equally, into the following two ultra-high-yield stocks, which sport an average yield of 8.39%!
How do you record dividends paid in cash? ›
A cash dividend journal entry is made when a company decides to distribute a portion of its earnings to its shareholders. Initially, the cash dividend journal entry involves debiting the “Retained Earnings” account, which reduces the company's equity, and crediting “Dividends Payable,” signaling the commitment to pay.
Is it better to receive dividends as cash or shares? ›
They also avoid tax liabilities in most cases. That said, there are two things to keep in mind: - Cash dividend options could create tax liabilities for shareholders. In the case of stock dividends with a cash option, you could pay tax on a dividend distribution that you haven't actually realized in cash.
What happens to stock price when cash dividend is paid? ›
A stock price adjusts downward when a dividend is paid. The adjustment may not be easily observed amidst the daily price fluctuations of a typical stock, but the adjustment does happen. This adjustment is much more obvious when a company pays a "special dividend" (also known as a one-time dividend).
How to declare a cash dividend? ›
Notify the Stockholders
- calculate the cash amount to be paid to the shareholders, both individually and in the aggregate.
- fix a record date for determining the stockholders who will be entitled to receive the dividend (based on the laws of your state)
- determine the payment date, and.
- send a notice to the stockholders.
