Should I Have a Taxable Brokerage Account?

By Geoff Schaefer

Geoff is a Wealth Advisor with Intergy Private Wealth. He writes for The Steadfast Fiduciary to help people live with an abundant heart, open mind, and boundless generosity.

August 8, 2023

-Start a Roth IRA. 

-Participate in your company’s 401(k) up to the employer match. 

-Max out your 401(k).

These are all pieces of advice we hear when investing.  None of them are wrong, but there is a chance they are not completely right either.  If a married couple are both working and following these first steps to investing, they are saving $58,000 ($6,500 for each IRA and $22,500 into each 401(k)) a year- an incredible savings rate. Tough to poke holes in any plan that has this level of savings.  The one I will suggest is flexibility.  Throughout life, flexibility is key. The amount of life changes that occur between 25 and 50 is staggering.  Job changes, marriage, kids being born, kids starting school, buying a first home, starting a business, selling a business, kids going off to college, empty nesting, and that’s only including the things that people plan on. All those things occur a full decade before you can withdraw the $58,000 a year you have saved away in tax sheltered retirement accounts. So, while retirement is looking awesome, what about all the life that occurred in the meantime?  Perhaps a flexible investment option is worth considering.

Enter a taxable (non-qualified) brokerage account.  A Swiss army knife of investment accounts.  This type of account could be started with no goal in mind.  The purpose and use can change.  The time horizons can shift.  You know you don’t need the cash today but think you may want it in the future. It can start as a down payment account, turn into a college fund and end in a retirement and gift giving asset. 

The arguments against include, it’s lack of a tax shelter (usually told to you by an insurance agent), no tax deduction, and no tax-free withdrawals.  The only real knock on this account type is the potential taxes you may pay on the gains, dividends and interest.

Here is a list of reasons why you SHOULD have a taxable brokerage account, starting with:

  1. The tax burden of the account is often over dramatized. According to Tax Foundation, 129 million US tax filers file at a tax bracket of 25% or lower.  That’s out of the 137 million households that files taxes. If you average out all taxpayers in the 15% tax bracket, the effective tax they pay is below 7% due to credits and the standard deduction. So, if you make interest and dividends in a brokerage account, most Americans will pay less than 7% of that income in taxes. Yes, higher income earners will pay more, but we can get to how to minimize that later on. Point here is, taxes should not be the deciding factor for many savers and a financial planning decision should never be made solely based on tax ramifications.
  2. Capital Gains are taxed more favorably than ordinary income.  When you earn a dollar at your job, it is considered ordinary income and taxed at rates referenced above.  When you hold onto an investment for more than a year, it is considered a long-term capital gain.  These rates are different than ordinary income, more favorable (see figure below). As a matter of fact, at certain income levels, the tax rate is 0%.  When financial planning, you can identify gap years, sabbatical, early years in retirement when these assets can be sold and result in no tax burden whatsoever.  The opportunities for this are more common than you may think.
  • Flexibility.  An IRA it is meant for retirement, a 529 Account is meant for college, a brokerage account is meant for…anything.  House, college, cars, slush fund, boats, giving… you name it.  It is the best account to have when you don’t quite know how to commit funds to a specific cause quite yet.  I often meet with clients who have extra money to save. Sometimes it is hundreds, sometimes thousands of dollars a month that they don’t need in their cash savings and don’t want in their retirement savings. Sometimes they have young kids and aren’t sure what college will look like in 15 years. Sometimes they are career changing and don’t know if going back to school is an option. Perhaps they want an early retirement at age 50 or sabbatical year but know that desire may change with time.  A brokerage account is the only account that can simultaneously address all these needs while being able to be fully flexed behind one at any time. It allows you to plan for the unknown, while leaving your tax deferred accounts to gown and compound over longer periods of time- what they are designed to do.
  • Investment Options are nearly limitless.  In Roth IRAs, some limitations for investments may exist.  In 401(k)s, you get much much more limited.  In banks accounts, you may be able to access some CDs and money markets. In taxable brokerage accounts, you name it and it is available.  ETFs, mutual funds, stocks, CDs, bonds, structured products, REITs, cryptocurrencies, etc. Now, while this is a pro of this account, without constraint and guidance this could easily become a rope by which you hang yourself.  With some direction though, have a flexible account lets you diversify and possibly follow some of your passions while investing for the future.
  • No income limits on contributions.  This simply means it is an account that sometime who just started their career can open and keep contributing to even if they become the CEO of a fortune 500 company. Every year, you can contribute money and any year you’d like, you can withdraw money without penalty.
  • Ability to tax plan within the account.  I already mentioned the potential to withdraw money while paying long term capital gains rates on the money earned.  On top of that, you can invest in a way that can grow your portfolio while limiting the tax liability you see in a certain year.  Index funds, ETFs and direct indexes all provide tax efficient ways to limit the income you are forced to pay tax on while allowing your funds to grow with the market.  A method called “tax loss harvesting” can actually cancel out taxable gain while having little to no effect on the long-term growth of the account.  This bullet point warrants its own post in the future but is worth mentioning now.
  • Last, is estate planning and the Step-Up in Basis.  This is a powerful tool for generational wealth transfers.  Any funds that are in this type of account will receive a step up on the basis of the date of the owner’s passing.  Here’s how it works: Grandma bought XYZ stock at $5 and as of the day she passed away, it was worth $50.  When her grandchildren receive the stock as inheritance, they can sell it and record a tax basis of $50.  So, the $45 of gain that grandma experienced was never taxed.  Coincidentally, this same method can occur while living if the stock is gifted to charity.  A powerful giving tool!

So, should you put money in retirement accounts? Absolutely! Should you follow a checklist and max out all tax deferred accounts before you look at other option? For most people, probably not.  We make great plans and life is what occurs in the meantime.  A taxable brokerage account is a way of surrendering to that.  The downside of this account type are not enough to outweigh the flexibility and peace of mind that comes with admitting that we don’t know what the future holds. In financial plan, we should absolutely draw a map that lays out how to get from where we are now to retirement efficiently.  Part of that plan should also be accounting for all that happens in between.


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