Email FacebookTwitterMenu burgerClose thin

Interest vs. Dividend: Income Comparison and Examples

Byline profile imageEdited by Becca Stanek
|
Byline profile imageEdited by Arturo Conde, CEPF®
Published on
| fact checked badgeFact Checked
SmartAsset maintains strict editorial integrity. It doesn’t provide legal, tax, accounting or financial advice and isn’t a financial planner, broker, lawyer or tax adviser. Consult with your own advisers for guidance. Opinions, analyses, reviews or recommendations expressed in this post are only the author’s and for informational purposes. This post may contain links from advertisers, and we may receive compensation for marketing their products or services or if users purchase products or services. | Marketing Disclosure
Share

Interest income and dividend income are two ways that investors can earn money from their holdings. However, they come from very different sources and have different tax treatments. Interest income usually comes from lending arrangements, such as bonds, savings accounts or certificates of deposit (CDs), and is taxed as ordinary income. Dividend income, meanwhile, represents a portion of company profits paid out to shareholders. Depending on whether it’s “qualified” or “non-qualified,” it may be taxed at favorable rates.

Working with a financial advisor can help structure your portfolio for both growth and tax efficiency.

What Is Interest Income?

Interest income is the money you earn when you lend your capital to an institution, business or government in exchange for regular interest payments. Unlike dividends, which are contingent on company profitability, interest payments are contractual and generally fixed.

Common sources of interest income include:

For example, if you buy a $10,000 corporate bond with a 5% annual coupon, you’ll earn $500 in interest income per year. This predictable stream of income makes interest-bearing securities popular among retirees and conservative investors.

From a tax perspective, most interest income is classified as ordinary income. That means it’s taxed at your marginal income tax rate, which could range from 10% to 37% depending on your income bracket. That said, certain securities, like municipal bonds, may be exempt from federal (and sometimes state) taxes.

What Is Dividend Income?

Dividend income comes from company profits paid to shareholders, but payments are not guaranteed.

Dividend income comes from ownership rather than lending. When you own shares of a company that distributes profits, you receive dividend payments, typically on a quarterly basis. Unlike interest, dividends are not guaranteed; companies can raise, cut or eliminate dividends depending on profitability.

Common sources of dividend income include:

  • Dividend-paying stocks (blue-chip companies are a common example)
  • Exchange-traded funds (ETFs)
  • Mutual funds focused on dividend strategies

For example, if you own 100 shares of a company that pays an annual dividend of $2 per share, you’ll receive $200 in dividend income each year. Many investors choose to reinvest dividends through a dividend reinvestment plan (DRIP), compounding their returns over time.

Dividends fall into two tax categories:

This distinction makes a big difference in after-tax returns, especially for higher earners.

Key Differences Between Interest Income vs. Dividend Income

Although both represent ways to earn money from investments, interest income and dividend income differ in key respects:

  • Source of income: Interest comes from lending arrangements; dividends come from ownership of company shares.
  • Predictability. Interest income is fixed and contractual, while dividends are discretionary and can change.
  • Risk profile: Bonds and CDs typically carry lower risk than stocks, whereas dividends are subject to company performance.
  • Taxation: Interest is almost always taxed at ordinary income rates. Dividends, by comparison, may qualify for lower tax rates.
  • Portfolio role: Interest provides steady income and stability. Meanwhile, dividends offer growth potential and compounding benefits.

Tax Considerations and Planning Strategies

When comparing interest income vs. dividend income for tax planning purposes, here’s what to keep in mind: 

  • Interest taxation: Nearly all taxable interest is reported on IRS Form 1099-INT and taxed as ordinary income. For someone in the 32% tax bracket, $5,000 of interest translates to $1,600 in federal taxes owed.
  • Dividend taxation: Qualified dividends receive preferential tax treatment. For example, $5,000 of qualified dividends for someone in the 15% capital gains bracket would result in $750 of tax liability instead of $1,600.

Because of these distinctions, tax planning can make a substantial difference. Investors often hold interest-bearing assets in tax-advantaged accounts like IRAs or 401(k) plans while keeping dividend stocks in taxable brokerage accounts for better efficiency.

Interest Income vs. Dividend Income: Which Is Better for Investors?

Neither interest nor dividend income is inherently better. Which one makes sense for you depends on your financial situation, goals and tax bracket.

Retirees seeking predictable income streams often prefer the interest they get from bonds or CDs. These investments provide stability, even if returns are modest.

Growth-focused investors, however, may prefer dividends from dividend-paying stocks, especially if they reinvest dividends over decades. Dividend growth stocks also have the potential for capital appreciation in addition to income.

Many investors benefit from holding both types of income-producing assets. Interest provides safety and liquidity, while dividends provide growth and favorable tax treatment.

Working with a financial advisor can help determine the right mix based on your time horizon, risk tolerance and tax situation.

Bottom Line

Interest can give stability, while dividends offer growth and tax benefits.

Both interest income and dividend income can play important roles in a well-diversified portfolio. Interest income offers predictability and stability, while dividend income offers growth potential and favorable tax treatment. The choice between them depends largely on your goals, risk tolerance and tax bracket. 

Investment Planning Tips

  • A financial advisor can help you create a plan to manage your portfolio. 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.
  • If you want to diversify your portfolio, here’s a roundup of 13 investments to consider.

Photo credit: ©iStock.com/champpixs, ©iStock.com/Jacob Wackerhausen, ©iStock.com/Jacob Wackerhausen