7 things you may not know about dividends

I recently dug into the pros and cons of dividend reinvestment. Readers of the article sent me questions about other dividend-related topics. Here are some of the most common questions I got:

What should I know about reinvested dividends and wash sales?

Reinvesting dividends means purchasing additional shares, which can complicate sales or tax-loss harvesting in taxable accounts. The IRS' wash-sale rules prohibit claiming a tax loss after a sale if you've purchased the same or ''substantially identical'' security 30 days before or after selling. You could wait at least 30 days after a dividend before selling, and make sure to sell at least 30 days before the next dividend, but to reduce hassle, it's probably best not to reinvest dividends for holdings that you plan to sell soon.

If I reinvest dividends, will I end up with fractional shares that are difficult to sell?

Reinvesting dividends typically means purchasing small amounts that get added to your existing stock/fund position. You'll probably end up with fractional shares, where you own only part of a share. Most major brokerages let you sell fractional shares, but you typically need to sell fractional shares as a market order, and liquidating fractional shares may take an additional day.

How are dividends taxed?

For stocks and stock funds, the tax rate depends on whether the dividend is qualified or nonqualified (also called ordinary). Dividends are qualified if you meet the 60-day holding requirement within a 121-day window around the ex-dividend date; these are taxed at capital gains rates — 0% or 15% for most people. Others are taxed as ordinary income. Dividends from holdings that don't meet these requirements are nonqualified and are taxed as ordinary income.

Are reinvested dividends taxable?

As I mentioned in another article, dividends for holdings in taxable accounts are taxable whether taken in cash or reinvested. If you reinvest dividends, you'll need to add each dividend to the holding's cost basis. You could end up with many separate tax lots with different cost-basis levels. When you sell the stock, you'll need to match each sale with a specific tax lot.

Are stocks that pay dividends better?

Money is fungible — it doesn't matter whether you receive it as income or capital appreciation. A company's value shouldn't depend on whether it pays a dividend. However, behavioral finance researchers have found that many investors perceive dividends as more stable and predictable than capital gains. Tax issues are another important consideration.

How do dividend-oriented strategies perform in a recession?

Can I live off my portfolio's dividends and interest income in retirement?

Some investors like this approach. Dividends can create steady income similar to a regular paycheck, and many investors like the idea of leaving their principal untouched. However, it can be tough to create a portfolio that generates enough yield for an income-only approach, especially one that keeps pace with inflation.

An income-only approach to support retirement spending might mean you'd need to amass a larger portfolio. By the same token, an income-focused approach means you would likely be underspending during retirement and might end up with a large portfolio balance after death. That might appeal to retirees who have a strong interest in leaving a bequest, but limits your spending while you're alive.

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This article was provided to The Associated Press by Morningstar. For more personal finance content, go to https://www.morningstar.com/personal-finance.

Related Links:

When to Reinvest Dividends (or Not)

https://www.morningstar.com/portfolios/when-reinvest-dividends-or-not

Tax-Loss Harvesting Isn't Just for Downturns. Here's Why:

https://www.morningstar.com/portfolios/tax-loss-harvesting-isnt-just-downturns-heres-why