How Do I Avoid Paying Taxes on Dividends?

Dividends can be a powerful source of investment income, but the tax bill that comes with them often catches investors off guard. Whether you’re building a retirement portfolio, reinvesting for long-term growth or relying on dividends for steady cash flow, understanding how to minimize taxes is essential to keeping more of your earnings. The good news is that the tax code offers several strategies, both simple and sophisticated, that can meaningfully shrink what you owe. Learning how dividends are taxed and how to position them wisely can help you build a more efficient, profitable investment plan.

A financial advisor can help you employ dividend investing in your portfolio.

How Do Dividends Work?

Dividends are payments investors get from owning shares of some companies. Companies that are profitable may distribute some of their profits as cash payments or stock dividends as a way to reward shareholders for investing in the business. Dividend-paying stocks are popular alternatives to bonds for investors who want to generate passive income. Retirees often invest in dividend-bearing stocks so they can pay their living expenses without having to sell investments.

Like all income, dividends are subject to taxes. The tax rates depend on whether dividends are considered qualified or nonqualified. Ordinary or non-qualified dividends are paid by stocks that are owned for less than the required holding period. These dividends are taxed at an investor’s ordinary income tax rate. Qualified dividends, which are paid by stocks that are owned for at least the required holding period, are taxed at capital gains.

Long-term capital gains rates are generally lower than ordinary income rates and fall into the rate brackets of 0%, 15% or 20%. Rates are based on the taxpayer’s income and most taxpayers are in the 15% capital gains bracket. For example, an investor who qualifies for a 15% long-term capital gains tax rate would pay $1,500 in taxes on $10,000 in qualified dividends.

How to Avoid Taxes on Dividends

Taxes on dividends may be reduced or avoided in certain cases, depending on whether the dividends are qualified or ordinary.

There are a few strategies for avoiding taxes on your dividends, depending on whether they’re qualified or ordinary dividends:

Roth retirement accounts: A Roth IRA is funded with after-tax money. Once a person reaches age 59 ½, qualified withdrawals can be made tax-free. So any dividends paid out by stocks owned in a Roth account would be free of taxes, as long as the dividends were withdrawn after age 59 ½ and at least five years after the account was opened.
Qualifying for zero capital gains tax: Capital gains taxes are graduated, with higher-income investors paying higher rates. Investors in the lowest income bracket owe zero capital gains taxes. Brackets change annually. For example, a married couple filing jointly with taxable income of $98,900 or less in 2026 ($96,700 or less in 2025) would pay no capital gains tax on qualified dividends. Strategies such as contributing to retirement accounts and health savings accounts (HSAs) may reduce your income below the zero-capital gains tax threshold. As a result, you wouldn’t owe any taxes on qualified dividends.
Education plans: Tax-advantaged 529 plans allow tax-free growth and withdrawals as long as the money is used to pay qualifying education expenses. So placing funds into a 529 plan and using the money to buy dividend-paying stocks will allow you to accumulate dividends tax-free and also withdraw the money without owing taxes. However, this only works if the withdrawal amounts go for qualified education expenses such as tuition and books.
Other retirement accounts: Traditional IRAs and 401(k)s are funded with pre-tax dollars and can reduce taxable income in the year contributions are made. Investment income, including dividends, is not taxed while the funds remain in the account. However, all withdrawals are taxed as ordinary income, regardless of whether the underlying earnings came from dividends or capital gains. Holding dividend-paying stocks in a traditional IRA or 401(k) defers taxes until withdrawal, but it does not provide preferential dividend or capital gains tax rates.

How Can Dividends Help Your Taxes?

While dividends are often taxable, they can affect taxes differently depending on how they are structured and where they are held. Qualified dividends are generally taxed at long-term capital gains rates rather than ordinary income rates, though higher-income taxpayers may also be subject to the 3.8% net investment income tax (NIIT). This treatment can result in a lower tax rate than ordinary income in some cases, but the overall impact depends on income level and applicable surtaxes.

Dividends can also be tax-advantaged when held in retirement accounts like IRAs or 401(k)s. Inside these accounts, dividends grow tax-deferred, or even tax-free in a Roth IRA, allowing you to reinvest earnings without worrying about annual tax liabilities. Over time, this compounding can meaningfully accelerate your portfolio’s growth.

By choosing the right accounts and understanding how different types of dividends are taxed, you can use dividend income to strengthen your investment strategy while keeping more of what you earn.

Asset Location: Where You Hold Dividend Stocks Matters

Dividend taxes are influenced as much by account placement as by tax rates. Holding the same dividend-paying stock in different accounts can produce very different after-tax results. This makes asset location a practical planning decision, not a secondary detail. Investors who ignore where dividends sit often pay more in taxes than necessary, even when using tax-efficient securities.

Taxable brokerage accounts tend to work best for qualified dividends from U.S. companies and certain foreign firms that meet IRS requirements. These dividends receive long-term capital gains treatment when holding period rules are met. They may also allow the use of tax-loss harvesting to offset other income. In contrast, REITs and funds that generate non-qualified dividends are generally less efficient in taxable accounts because distributions are taxed at ordinary income rates.

Tax-advantaged retirement accounts change that outcome. Traditional IRAs and 401(k)s defer taxes on dividends entirely until withdrawal, which can be useful for assets that would otherwise generate a larger annual tax drag. Roth IRAs go further by eliminating taxes on qualified withdrawals altogether, making them a logical home for dividend strategies focused on reinvestment and long-term growth rather than near-term income.

Asset location decisions also affect flexibility later in life. Dividends in taxable accounts can provide cash flow without triggering required minimum distributions, while dividends inside traditional retirement accounts contribute to balances that may be subject to mandatory withdrawals. Aligning dividend placement with future income needs, tax brackets and withdrawal timing can improve after-tax outcomes without changing the underlying investments.

Bottom Line

Dividend-paying stocks can generate income, with qualified dividends sometimes taxed at lower rates or not taxed, depending on income level and account type.

Investing in dividend-paying stocks can generate income while also preserving the potential for capital appreciation. Dividend income may be taxed at capital gains rates that are lower than tax rates on ordinary income as long as the shares are held for at least the required holding period. You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains or if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.

Investing Tips

Consider checking with a financial advisor for suggestions about tax-efficient ways to generate income through dividend investing. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
To plan well for your financial future, you need to have some idea of how much your investments will be worth in the future. SmartAsset’s Investment Return and Growth Calculator can help you estimate how much your portfolio could be worth. Provide the amount of money you’re starting with, the additional contributions you plan to make, your expected rate of return and how long you want to let the money grow. The calculator will then give you the future estimated value of your portfolio.