by Kyle Thompson, MBA
Many people are familiar with IRAs, 401ks, and similar qualified accounts, which are tax advantaged in one of two ways: they either let you deduct your contributions from your income now (and will be taxed when you withdraw later), or they allow you to pay taxes on the contributions now, rather than when you withdraw later (commonly known as the Roth option). These are wonderful options that you should absolutely be using, but they also come with all sorts of rules and restrictions, including income phaseouts, contribution limits, tax penalties for early withdrawal, etc. Many times, clients are investing money for use before retirement, or they are retiring before the official 59.5 retirement age, or they want to invest above the contribution limits that qualified retirement plans allow.
The solution for this? A brokerage account (also known as a taxable account). Simply put, a brokerage account is just a savings account you can hold investments of any kind in. The only downside is that dividends and capital gains are taxed in the year they are received (usually every year), so if you aren’t efficient with tax management, you can end up owing more in taxes than you might expect. However, there are quite a few benefits-
- No income limits
- No contribution limits
- No restrictions on withdrawals (you can take the money out at any time)
- Generally preferential tax rates (15-20%, or 0% if your taxable income is low enough!)
- Can be used as a line of credit with low interest rates (this is what the super rich do)
- Receives a step up in basis when you die (which is important for estate planning purposes)
- Tax loss harvesting in bad market years can provide you with a tax deduction that can be carried forward into future years
Ultimately, a brokerage account provides you with the flexibility that other account types do not. This of course comes with the tradeoff of getting a 1099 every year, but if you are efficient with your investments inside the account, that shouldn’t amount to much. Personally, I save 10% of my income into a brokerage account, and another 10% into a qualified account. This gives me the tax diversification and flexibility I need, and allows me to save for goals that may come up before retirement. Some clients save even more into this account, especially ones that are planning for sabbaticals or early retirement.
If you would like to learn more about how this applies to your specific situation, feel free to schedule a consultation below (you knew a shameless plug was coming eventually). Or not. That’s cool too, I guess.
This article is for information and entertainment purposes only, and does not constitute investment advice. Kyle Thompson, MBA is the founder of Leetown Advisors, a fee-only wealth management firm. For further inquiries or suggestions, please email Kyle at kylet@leetownadvisors.com.
