A Retirement Portfolio Might Benefit from a Taxable Brokerage Account
In the world of personal finance, choosing the right investment vehicle can greatly impact one's financial future. Two common types of accounts that often confound investors are taxable brokerage accounts and retirement accounts, such as 401(k)s, traditional IRAs, and Roth IRAs. Here's a breakdown of the key differences between these two categories.
Tax Treatment
Taxable brokerage accounts, unlike their tax-advantaged counterparts, are taxed annually on earnings like capital gains, dividends, and interest. These taxes apply when the earnings are realized, such as when you sell an asset for a gain or receive dividends. Long-term capital gains (assets held for more than a year) and qualified dividends benefit from favourable tax rates, while short-term gains and non-qualified dividends are taxed at ordinary income rates. Conversely, contributions to tax-deferred accounts like 401(k)s or traditional IRAs are often made pre-tax, reducing taxable income in the year contributed. Earnings grow tax-deferred until withdrawal, at which point they are taxed as ordinary income. Roth IRAs, however, have contributions made with after-tax dollars, but earnings grow tax-free, and qualified withdrawals (after age 59½ and meeting the 5-year rule) are completely tax-free.
Contribution Limits
While there are no contribution limits for taxable brokerage accounts, contributions to tax-advantaged retirement accounts like 401(k)s, traditional IRAs, and Roth IRAs are subject to annual limits. In 2025, the combined limit for IRAs (traditional and Roth) is $7,000 annually, with an additional $1,000 catch-up for those 50 and older. 401(k) contribution limits are generally higher but were not detailed in the provided information.
Withdrawal Rules
Taxable brokerage accounts offer greater flexibility in terms of withdrawals, as funds can be withdrawn at any time without penalties or age restrictions. Withdrawals from retirement accounts, on the other hand, incur penalties and restrictions. Withdrawals before age 59½ usually incur a 10% early withdrawal penalty plus ordinary income taxes, with some exceptions. Roth IRA contributions (not earnings) can be withdrawn anytime without taxes or penalties.
Required Minimum Distributions (RMDs)
Taxable brokerage accounts do not have required minimum distributions, allowing you to leave money invested indefinitely. Traditional IRA and 401(k) accounts, however, require minimum distributions once the account holder reaches a certain age (currently 73). Roth IRAs do not require RMDs during the account owner’s lifetime.
Benefits Comparison
Taxable accounts provide maximal flexibility, with no limits on contributions or withdrawals, and the ability to use tax strategies like tax-loss harvesting. However, they are taxed on realized gains and income, which can reduce compounding growth. Tax-advantaged retirement accounts, on the other hand, offer tax deferral or tax-free growth, but come with contribution limits, withdrawal rules, and RMD obligations.
In summary, taxable accounts provide unrestricted access and unlimited contributions but face annual taxation on gains and income, while retirement accounts offer tax advantages and protections but come with contribution limits, withdrawal rules, and RMD obligations.
A taxable brokerage account can be used to save for various goals, such as buying a car or a house in the future. However, it's essential to consider the tax implications of these accounts and how they fit into your overall financial strategy. For instance, Roth IRA investment earnings can be subject to penalties if withdrawn before age 59 1/2 and the account has not been held for at least 5 years. Capital gains from investments held for a year or less are taxed at the ordinary income rate, which can be as high as 37%. In a taxable brokerage account, you pay tax on interest, dividends, and capital gains in the year they are received.
If you've maxed out your retirement plan contributions, a taxable brokerage account can be a good place to direct extra savings. With a Roth account, you pay income tax on your contributions, but distributions are tax-free in retirement. Traditional IRA and 401(k) accounts require minimum distributions once the account holder reaches a certain age (currently 73). It's always a good idea to consult with a financial advisor to determine the best investment strategy for your unique circumstances.
[1] IRS.gov - Publication 590-A: Contributions to IRAs [2] IRS.gov - Publication 590-B: Distributions from IRAs [3] IRS.gov - Publication 559: Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) [4] IRS.gov - Publication 505: Tax Withholding and Estimated Tax [Note: The provided links are for informational purposes only and do not constitute an endorsement of the Kiplinger Tax Letter.]
Investing in a taxable brokerage account allows for maximum flexibility in terms of contributions and withdrawals, but it is taxed annually on earnings like capital gains, dividends, and interest. On the other hand, personal-finance decisions involving retirement accounts, such as 401(k)s and IRAs (traditional and Roth), offer tax deferral or tax-free growth, although they are subject to contribution limits, withdrawal rules, and RMD obligations.
