Plain vanilla brokerage accounts get a bad rap. All the conversations go to retirement accounts: how, when and why to fund them; what the rules are; strategies on maximizing them. You can pick up any financial publication and read about them. I’ve been a financial planner for 20 years and it is the rare individual who asks me if there are any options for saving even more after they have maxed-out their company retirement plan and maybe an additional Roth or Traditional IRA. Like anything, there are pros and cons to investing in a taxable account, but you might be surprised to learn that they deserve some love too.
Taxable brokerage accounts, under the right circumstances, can provide savers with a high degree of flexibility and built-in features that provide great value to owners. Unlike retirement accounts, taxable accounts don’t have income restrictions, contribution limits, rules on when you have to take distributions or limitations on your employment status. You can contribute any amount you like at any time you want and also not be held to only a few choices of what you can invest in like most employer plans. As long as you buy and hold an investment in a taxable account, it can grow over time without tax consequences. If you take a distribution from a pre-tax retirement account, the whole thing will be taxed at ordinary income rates, the highest tax rates there are. If you hold an investment in a taxable account for at least one year, you receive a favorable capital gains tax rate, currently at 0-20% depending on your income, on only the gain in the value of the asset since the original investment. In a retirement account, if one of your holdings loses value, there is no upside for the saver. In a taxable brokerage account, if one of your investments goes down in value and you make the decision to sell it, you can net the loss in value against a gain in another asset in the same account and not be liable when taxes are due if the net loss exceeds the net gain. Additionally, if there is loss left over after the gain has been netted out, you can take up to $3,000.00 of that extra loss and deduct it from your income from other sources. Still not used up all the loss of that unwanted asset? You can deduct up to $3,000.00 per year against your income until the loss is used up. Another really valuable feature of taxable accounts is the fact that the accounts allow heirs to receive your legacy on a “stepped-up” basis. Let me explain with an example. Maybe you bought a stock several years before your death and held it. Over time, it appreciated from the date you bought it and, at the end of your life, you were sitting on a significant gain in that asset. If you sold that stock the day before you died, you would owe tax on your considerable gain. If instead, that stock was still intact on the date of your death, your heirs would inherit that stock with a cost based on the price at your date of death rather than the original cost. Your heir could then decide to sell the stock soon after your passing and pay no or very little capital gains tax.
Sound too good to be true? Now it’s time to address the not so good. If you’re a parent of a student who will be seeking financial aid for higher education, taxable account balances are counted against you as opposed to retirement accounts which aren’t factored into how much aid you will receive. Also, if you are sued, retirement accounts are protected from creditors but taxable accounts are fair game. The low-cost fix for this is to buy an umbrella insurance policy from your insurance professional, but there is still a cost. Then there’s the fact that savers have to be more disciplined with taxable accounts than they can be with retirement accounts. Employer plans and IRAs have built-in penalties on taking disbursements before attainment of a certain age or under certain circumstances. Taxable brokerage accounts are much easier to tap. Lastly, dividends paid into a pre-tax retirement account are not taxed until they are eventually paid out to the account holder. Dividends paid into a taxable account are taxed in the year they are received, though at a favorable rate lower than that you would pay for ordinary income.
So what’s the verdict? You have to contend with some drawbacks, but, on balance, there’s a lot to like about taxable brokerage accounts. Hopefully, this overview will persuade you that the best prepared savers enter retirement with a sound mix of tax-deferred (pre-tax retirement accounts), tax-free (Roth retirement accounts) and taxable brokerage accounts.
Do you have more questions? I’d love to be of help. Please call me at 563-949-4705 or email me at firstname.lastname@example.org.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory services offered through J.W. Cole Advisors, Inc. (JWCA). Huiskamp Collins Investments, LLC and JWC/JWCA are unaffiliated entities.