What this article covers
Tax-advantaged retirement accounts are usually a good choice, but Opher Ganel lays out nine situations when a taxable investment account serves retirement savers better, from high-fee 401(k) plans with no match to earning too much for a Roth IRA or wanting penalty-free access to your money. Three financial advisors add why taxable accounts’ lower long-term capital gains rates, step-up in basis and flexible withdrawals make them a valuable part of a retirement plan.
Key Takeaways
A taxable account can beat a 401(k) when your plan has high fees, no match or poor investment options
Opher Ganel argues that investing in an employer plan with very high fees and no match is a bad idea, and that a lineup of poor performers or no access to real estate and other asset classes are also reasons to invest elsewhere. A taxable account is also the only way to invest beyond IRS contribution limits on IRAs, 401(k)s, 403(b)s and HSAs.
Taxable accounts offer lower tax rates on long-term gains and a step-up in basis at death
Capital gains in a taxable account aren’t taxed until you sell, and long-term gains are taxed at far lower rates than the ordinary income rates that apply to traditional retirement account withdrawals. Michael Hunsberger of Next Mission Financial Planning notes that heirs receive a step-up in basis, and Nick Covyeau of Swell Financial says low-income retirees may be able to live off taxable distributions tax-free while delaying Social Security.
Holding Roth, tax-deferred and taxable accounts gives retirees the most tax flexibility
Because future tax laws are uncertain, Opher recommends having significant amounts in tax-free Roth accounts and HSAs, tax-deferred traditional accounts and general taxable accounts. David Edmisten of Next Phase Financial Planning points to taxable accounts’ lack of contribution and income limits and penalty-free withdrawals, and a larger taxable balance also reduces future Required Minimum Distributions.
Michael Hunsberger
Nick CovyeauWhile tax-advantaged retirement accounts are often a great choice, there are several situations when a taxable account may better serve you.
Are tax-advantaged accounts good or bad for retirement investing?
For most of us, the answer is that they’re good, up to a point.
For example, if you’re earning a lot more now than you expect to spend in retirement, delaying taxes until retirement makes a lot of sense.
If you make a lot less now than you expect to spend in retirement, a Roth IRA or Roth 401k makes great sense – you pay lower taxes now and then pay no taxes on any of your withdrawals in retirement.
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When Is a Taxable Account Better for Retirement Savings? 9 Situations
Despite the above, there really are nine situations when using a taxable investment account for retirement investing is great.
1. You have no access to an employer retirement account
Some employers don’t offer a retirement account. Or, they may limit access until you’ve worked for them long enough and you want to invest money for retirement now.
2. You have access to an employer retirement plan, but there’s no match and fees are high
Some retirement plans have very high fees, so your long-term results will suffer. If, in addition, your employer offers no match, investing in such a plan is a bad idea.
3. You have access to an employer retirement plan, but the investment options have a poor record
All employer retirement plans have a limited set of investment options. If all the options in your employer’s plan are poor performers, you’re better off investing elsewhere.
4. You want to invest in asset classes not available in your employer’s plan
Employer retirement plans mostly limit you to mutual funds invested in stocks and/or bonds. If you want to invest in real estate or crypto (not my thing!), you’d be better off using a different account, even if it’s taxable.
5. You want to invest more than IRS limits allow
Each year, the IRS sets limits for how much you’re allowed to contribute to tax-advantaged funds. This is true for IRAs, 401(k) plans, 403(b) plans, and even Health Savings Accounts (HSAs) that aren’t considered retirement plans but are actually better for retirement than most “official” retirement plans.
If you’re privileged enough to be making so much that you can afford to invest for retirement more than those limits allow for, taxable accounts are your way to do just that.
6. You make too much to contribute to a Roth IRA
If you make too much, the IRS doesn’t allow you to contribute to Roth IRAs. You could consider making a so-called “back-door contribution” by contributing after-tax dollars into a traditional IRA and then converting them into a Roth IRA, but that’s a complicated process that may not be worthwhile if you already have a high balance in your traditional IRAs.
7. You make too much to deduct contributions to traditional IRAs
The IRS also doesn’t allow you to deduct your contributions to a traditional IRA once your income exceeds certain levels. You can still contribute with after-tax dollars and taxes on your earnings will be deferred. However, without the benefit of deferring taxes on the contribution, contributing to a traditional IRA is far less compelling.
8. You want penalty-free access to your investments
In some situations, you may want to have access to your investments in situations when the IRS assesses penalties on withdrawals from retirement accounts.
If that’s you, a taxable account is best.
Note, however, that once a Roth IRA has been open for five years, you can withdraw your contributions tax- and penalty-free at any time. If you go this route, you can’t later put the money back into the Roth account.
9. You plan to invest in assets that already enjoy preferential tax treatment
If you plan to invest in, say, individual stocks that you’ll hold for the long term, a taxable account is likely best for you. That’s because capital gains in taxable accounts aren’t taxed until you realize them by selling shares. At least as important, even then, the long-term capital gains tax rate is far lower than rates for regular income, which is withdrawals from non-Roth retirement accounts are taxed.
In addition, as Michael Hunsberger, ChFC®, Owner, Next Mission Financial Planning, LLC says:
Taxable investment accounts receive a step-up in basis at the death of the owner. If you plan to leave the investment account to your heirs, you could purchase non-dividend-paying investments and hold them until your death, and the capital gains would never be subjected to taxes. You could also donate appreciated shares for a tax deduction of their appreciated value if they’re held for over a year.
Nick Covyeau, CFP®, Owner and Financial Planner at Swell Financial, adds:
If your adjusted gross income (AGI) and spending are low enough in retirement, you may even be able to live off distributions from your taxable account tax-free, allowing you to delay Social Security and letting your tax-advantaged retirement accounts grow uninterrupted without paying current taxes.
The Bottom Line: Why a Mix of Account Types Gives You Flexibility in Retirement
While tax-advantaged retirement accounts are a great choice in many, if not most, circumstances, the above are nine situations when a taxable account might serve you better.
As David Edmisten, CFP®, Founder, Lead Advisor, Next Phase Financial Planning, LLC, says:
Although taxable accounts don’t offer the tax benefits of a 401k, IRA, or Roth IRA, they offer several advantages for retirement savings: no contribution limits, no income limits, penalty-free withdrawal anytime, and lower tax rates applied to gains.
If nothing else, the uncertainty of future changes to tax laws makes it wise to diversify your retirement-investment account types so you can pick and choose from which account you want to withdraw how much once you’re retired.
To have the greatest flexibility to optimize your tax planning in retirement, have significant amounts invested in:
- Tax-free Roth accounts and HSAs
- Tax-deferred traditional retirement accounts
- General taxable investment accounts
Finally, having a good chunk of your retirement investments in a taxable account will reduce your eventual Required Minimum Distributions (RMDs).
What to Read Next:
Frequently Asked Questions
When does it make sense to save for retirement in a taxable account?
The article lists nine situations: no access to an employer plan, a plan with high fees and no match, a plan with poor investment options, wanting asset classes the plan doesn’t offer, wanting to invest more than IRS limits allow, earning too much for a Roth IRA, earning too much to deduct traditional IRA contributions, wanting penalty-free access to your money, and investing in assets that already get preferential tax treatment, such as individual stocks held long term.
Should I invest in a 401(k) with high fees and no employer match?
According to the article, probably not. High fees erode long-term results, and without a match there is little to offset them, so investing in such a plan is described as a bad idea. A taxable account may serve you better.
What can I do if I earn too much to contribute to a Roth IRA?
The IRS doesn’t allow Roth IRA contributions above certain income levels. A backdoor contribution (contributing after-tax dollars to a traditional IRA, then converting to a Roth) is an option, but the article notes it is complicated and may not be worthwhile if you already have a high balance in traditional IRAs. A taxable account is the alternative.
How are taxable investment accounts taxed compared with traditional retirement accounts?
Capital gains in a taxable account aren’t taxed until you sell, and long-term capital gains rates are far lower than the ordinary income rates applied to withdrawals from non-Roth retirement accounts. One advisor interviewed adds that taxable assets receive a step-up in basis at the owner’s death, and that appreciated shares held over a year can be donated for a deduction of their appreciated value.
Why should retirees hold a mix of Roth, tax-deferred and taxable accounts?
Future tax law changes are uncertain, so holding all three account types lets you choose which account to withdraw from, and how much, once you’re retired. The article also notes that a meaningful taxable balance reduces your eventual Required Minimum Distributions.
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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.