Should You Cash Out Your Dividends if Money Is Tight?

It's a tough call to make.

As an investor, there are different ways you can make money by buying and holding stocks. One option is to hang onto your stocks until their share price appreciates in value, and then sell your shares at a price that's higher than what you initially paid. Another option is to sit back and collect dividends from the stocks you own.

When a company pays dividends to investors, it's basically sharing a piece of its profits. Not every stock pays dividends, as some companies prefer to reinvest that money into their respective businesses. But if you own dividend stocks, you have options when it comes to those dividend payments. You could either reinvest them, or you can cash them out.

Reinvesting your dividends gives you a prime opportunity to grow your brokerage account balance nicely. But if money has gotten tight, cashing out your dividends might be the better move -- or at least a necessary one.

A better alternative to credit card debt

In February, inflation was up 6% on a national level. And higher living costs have been putting a big strain on a lot of people.

If you're having a difficult time paying your bills due to inflation or another factor (such as having your working hours cut), then it could make sense to withdraw your dividend payments and use that money to cover expenses. While you'll lose out on the chance to reinvest that money, you might save yourself even more money if you're able to avoid racking up and carrying balances on your credit cards.

But if you don't need the money, then reinvesting your dividends is a smart move, because it's extra money you can put to work. Plus, many brokerage accounts let you set up dividend reinvestments automatically so you don't even have to think about it. Often, the way these work is that your dividends will be used to buy more shares (or fractional shares) of the companies that are paying them.

Will you be taxed on your dividends if you cash them out?

Dividend income is subject to taxes regardless of what you do with it. If you decide to reinvest your dividends, you'll be liable for taxes just as you will be if you cash them out.

To put it another way, you don't have to worry that cashing out your dividends will create a separate or additional tax liability. Rather, once those dividends land in your brokerage account, they're considered taxable income no matter what.

You can think about it the same way you would for your regular paycheck. You're going to be taxed on that money no matter how you spend it. Contributing some of your income to a traditional IRA or 401(k) will exempt a portion of your income from taxes, but otherwise, the IRS wants its share, regardless of whether you spend your paycheck on rent, food, or shares of stock in a brokerage account.

Dividends work the same way. And knowing that might help you feel better about withdrawing that money to pay bills, if that's the route you decide to take.