The Investment Account That Makes It Easier to Tap Into Your Money

Tax-sheltered accounts, especially company retirement plans, are “the easy button” for savers just starting out. They offer incentives such as matching contributions and tax breaks; contributions go in on autopilot; the money compounds without incurring taxes; and participants may even be automatically enrolled in an age-appropriate target-date fund if they don’t make an active choice.

Because of these widely heralded benefits, many investors focus their savings exclusively on their IRAs and 401(k)s and either skip investing in a taxable brokerage account or turn to one only after they’ve fully funded their tax-advantaged options. To be sure, taxable brokerage accounts don’t offer the same tax breaks that IRAs and 401(k)s do, and they don’t provide the same creature comforts and guardrails of company retirement plans. Yet, a taxable brokerage account can be a wonderful addition to investors’ toolkits, and not just for that rarefied subset of investors who have “maxed out” their tax-sheltered vehicles.

Here’s why.

Provides Maximum Flexibility and Liquidity

While tax-sheltered vehicles all come with limits on how much money you can stuff in them, taxable accounts carry no such restrictions. That makes them ideal for supersavers looking to amass additional assets.

Just as important, taxable accounts don’t carry strictures around withdrawals, offering maximum flexibility to address nonretirement goals. If you are socking money away for nonretirement goals like a home down payment, are building an emergency fund, or have your sights set on an early retirement, a taxable account will allow you access to your money without any strings attached, though you may owe taxes if your investments have appreciated over your holding period.

Taxable accounts are especially valuable in an era in which many workers are jumping in and out of the workforce: Just knowing that they have the financial wherewithal to step away for a while might make an otherwise grinding job easier to manage. Putting money away in a nonretirement account can also be a valuable savings strategy for young couples planning families, potentially allowing them to live on a single income for a few years when their children are young.

Can Offer Tax-Deferred Compounding and Tax-Loss Selling Opportunities

While IRAs and 401(k)s get a lot of attention for their tax breaks, it’s worth noting that you can readily simulate the tax-deferred compounding of those account types inside of a taxable account. The key is to choose investments that kick off limited taxable income and capital gains distributions. For equities, broad-market exchange-traded funds or index funds fit the bill nicely; the former, in particular, tend to deliver few capital gains payouts, but both are pretty tax-efficient. Meanwhile, income from municipal bonds is exempt from federal and, in some cases, state income taxes. Tax-efficient equities and munis make it possible to buy and hold a basket of securities for years inside a taxable account while owing very little in taxes on that portfolio during your holding period.

In addition to the ability to have your assets increase without owing a lot in taxes, investing in a taxable account also gives you the ability to harvest losses, something that is impossible (or at least quite cumbersome, in the case of IRAs) to do with investments you’re holding inside your tax-sheltered accounts. You can sell securities that are trading below your purchase price and use your loss (the difference between your purchase price and your sale price) to offset capital gains or, if you still have excess losses, up to $3,000 in ordinary income. Granted, tax-loss selling opportunities have been few and far between over the past 15-plus years, especially for investors who own mutual funds or ETFs rather than individual stocks. But in deep bear markets, the ability to engage in tax-loss selling is a rare silver lining. Investors who use the specific-share identification method of tracking their cost basis give themselves the greatest leeway to harvest tax losses; while their average purchase price on a security may be above the current share price, they may have specific lots of securities they picked up when prices were higher.

Beats Tax-Deferred Accounts When It Comes to Withdrawals

In addition to being able to keep your tax costs down while you own the securities in a taxable account, currently low capital gains rates also help you limit your tax costs when you eventually sell them. As recently as the late 1990s, a 20% long-term capital gains rate applied to investors in the 28% income tax bracket and above. Now, only investors with very high levels of taxable income (single filers with taxable income over $545,500 and married couples filing jointly with more than $613,700 in taxable income) pay a 20% long-term capital gains rate. Investors paying a 0% rate for long-term capital gains can also engage in tax-gain harvesting—essentially, selling appreciated securities and rebuying them immediately thereafter. In so doing, they reset their cost basis to a new, higher level, thereby reducing the capital gains tax they’ll pay if they eventually sell the security when their tax rate is higher.

The ability to pull your money out with limited tax liability (because capital gains rates are pretty benign right now) can prove particularly beneficial when you begin taking money out of your accounts during retirement. You’ll owe ordinary income tax on distributions from traditional IRAs and 401(k)s during retirement, and the timing and size of those distributions will be out of your control once you have to begin taking required minimum distributions. By diversifying your asset mix across taxable and Roth accounts, you’ll help ensure that at least some of your distributions will come out with low or no tax ramifications. Having taxable assets can also come in handy if you plan to convert part of your traditional IRA or 401(k) assets to Roth, in that you can use non-IRA assets to pay the tax bill.

Can Provide Tax Benefits for Your Estate

Finally, taxable accounts with highly appreciated assets are especially attractive for your heirs to inherit. If after your death they receive appreciated assets that you held in a taxable account, their cost basis in the asset will jump to whatever it was at the date of your death. That effectively washes out the tax burden on any gains those securities racked up during your lifetime. Even if your heirs end up selling the inherited assets shortly thereafter, you’ve still reduced the drag of taxes on your overall estate. Of course, that tax treatment could change, but for now, at least, the step-up makes inherited assets in a taxable account particularly advantageous for heirs.