Taxable Brokerage Accounts Are Great and Shouldn't Get a Bad Rap

Matthew Costa, CPA, CFP®, MAcc

Taxable brokerage accounts are great and shouldn’t get a bad rap (and I am willing to die on this hill). Taxable brokerage accounts tend to be considered less than favorable, but why does my opinion differ from popular belief?

To begin, taxable brokerage accounts are exactly as stated: taxable. This means the gains, dividends, and interest are taxable as realized.  This is different than qualified retirement accounts like traditional IRAs and 401(k)s where the taxation is considered “deferred’ and not taxed until an investor draws on the account.

Why do I consider taxable accounts great?  

  1. There is no penalty for early distribution from the accounts.  On the other hand, tax-deferred retirement accounts typically have a 10% penalty if drawing on the assets before age 60.
  2. When taxed, favorable long-term capital gains rates are likely to apply (after holding the security for a year or longer),and potentially a zero rate for the taxable account’s income.  On the other hand, tax-deferred accounts get taxed at higher, ordinary income rates.
  3. Taxable accounts get a step-up in basis upon the account owner’s death; in brief, any unrealized gains disappear and the heir inherits the account with no tax to pay. The heir’s basis is stepped up to the value of the security on the date of death. Conversely, tax-deferred accounts will be taxable to heirs when they distribute from the account.
  4. ou can borrow against this type of account, while the same option is not available for retirement accounts.
  5. Tax-efficient charitable giving is also an option with such accounts.
  6. There are no contribution limits based on income, unlike tax-deferred accounts.
  7. They can be a great tool for gifting in a tax-efficient manner because, unlike tax-deferred accounts where gifting typically does not make sense.
  8. You can capture tax-exempt interest that municipal bonds produce.

I hope my list above illustrates that it is worthwhile to save to these types of accounts when you have exhausted the limits of your retirement accounts.  It can even be smart to forego retirement account savings in some situations and preemptively allocate to a non-qualified taxable account. Taxable accounts can be a good thing if it can generate a reduced tax burden as a whole or accomplish other goals, like legacy planning or charitable giving.

There is a well-established hierarchy of savings.  It’s almost universally advisable to contribute to your workplace 401(k) to get the free money of an employer match (if your employer does so).  But, after that match, everyone’s facts are different. If you are saving to buy a business, want to gift assets, or want future flexibility for borrowing, perhaps more savings to non-retirement taxable accounts may make sense for you.  I am happy to walk you through any analysis you would like. As always, let us know if you have any questions.

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