When a company makes a profit, they can do one of three things: 1. Reinvest the profit back into the company, 2. Pay out the profit to shareholders in the form of a dividend or a combination of 1 and 2.
If you have dividend paying stock, you get a quarterly dividend. It will be pennies per share, and many pay the same amount every quarter. You have two options: 1. Reinvest the dividend, thus buy more of the stock or 2. Take the dividends as cash. Either way, if the stock is in a non-retirement account, the quarterly dividends are taxable to you. You are paying income tax on all those dividends every year.
Mutual funds holding stock, may also hold dividend paying stock. If this case, those dividends are passed on to you quarterly as a shareholder of the mutual funds. Some funds hold exclusively dividend paying stock while others have a mix. Again, you have the choice of reinvesting the dividend and buying more of the mutual fund or taking the dividend in cash. You will be paying tax on the dividends received if the fund is in the non-retirement account, no matter what your choice.
Mutual funds also have a capital gains pay out, normally in December. This happens when the fund management team has decided to sell a stock that has had a gain. That gain is handed on to you as the shareholder. It is a capital gain, not from you personally selling a stock or the mutual fund, but the fund itself selling a stock holding. Paying out a capital gain does not mean the fund’s value has increased.
With a capital gain from a mutual fund, you again have the choice of reinvesting it back into the fund or taking it as cash. You are taxed on the gain, no matter which decision you make if it is a non-retirement account.
In a retirement plan, dividends and capital gains are generally reinvested, buying more stock or mutual funds. Even if they are paid out in cash, no tax is due until money is withdrawal from the retirement plan.
No matter what you decided to do with your dividends or capital gains, remember that in a non-retirement plan, you will be paying taxes on that income.