Taxable Accounts vs. IRAs

How to Know When to Invest In a Taxable Account vs IRA

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When comparing taxable accounts with IRAs for your saving and investing, there are several variables you'll need to consider before choosing the best account type for you. Should you invest all of your long-term savings in an IRA? When is it best to use taxable investment accounts? Or is it beneficial to use several different account types?

Finding the best account type for your savings and investing goals can be simple if you know the basic facts and benefits of taxable accounts vs IRAs. Here's a breakdown on how taxable brokerage accounts and IRAs work and the primary benefits of each.

What Is a Taxable Brokerage Account?

A taxable brokerage account is an individual and joint brokerage account established for trading (buying and selling) investment securities, such as stocks, bonds, mutual funds or exchange-traded funds (ETFs). These accounts are referred to as taxable brokerage accounts because they are taxable to the investor.

Taxes incurred in a taxable brokerage account include realized capital gains and dividends or interest earned.

Taxable Accounts vs Traditional IRAs and Roth IRAs

There are several potential reasons to invest in taxable accounts compared to IRAs:

  • Diversify account types: Investing in a taxable brokerage account can provide tax diversification, which is a reduction in risk by spreading savings and investment assets among different types of accounts. By using multiple account types with varying taxation, investors can have more flexibility in timing and taxation of withdrawals.
  • Penalty-free withdrawals: If you are saving for retirement and you think you may need some of your long-term savings prior to age 59 1/2, you can avoid the 10% "early withdrawal penalty" associated with IRAs.
  • Potential for lower taxation: Long-term gains on investments sold from taxable accounts are taxed at the 15% capital gains rate. For some investors, this rate is lower than their federal income tax rate. For this reason, a taxable brokerage account may be more beneficial for wealthy individuals in higher tax brackets, compared to traditional IRAs, where withdrawals are taxed as ordinary income.
  • No income limit: Some people have the fortunate problem of not being able to contribute to an IRA because of income limits. For example, a couple who file joint tax returns and are covered by their employers retirement plan will be phased out of making traditional IRA contributions starting at $104,000 of modified adjusted gross income in 2020 and $105,000 in 2021.

When to Invest in a Taxable Account, Traditional IRA or Roth IRA

Here is a breakdown of when to invest in a taxable account, a traditional IRA or a Roth IRA.

Invest in taxable brokerage account if:

  • Your income exceeds the maximum for contributing to IRAs.
  • You've maxed out your contributions to an IRA and your employer-sponsored retirement plan, such as a 401(k).
  • You need to make withdrawals from your investment account prior to age 59 1/2.

Invest in a traditional IRA if:

  • You expect to be in a lower tax bracket in retirement.
  • You need tax deductions from income.

Invest in a Roth IRA if:

  • You expect to be in a higher tax bracket in retirement than you are now.
  • You don't currently need deductions from taxable income.

For more information on investing in different account types, see our articles on the best investment types for taxable accounts and the best investment types for IRAs.

The Bottom Line

Taxable brokerage accounts and IRAs have various taxation rules and unique benefits. Some investors may be able to take advantage of multiple account types. For example, if your employer offers a 401(k) with a match, it's wise to contribute just enough to that plan to maximize the match.

If you can afford to invest beyond your employer's retirement plan, it's generally wise to contribute to a Roth IRA, which has a maximum contribution of $6,000 ($7,000 if you are 50 or older) in 2020 and 2021. If you are able to save more, open a taxable brokerage account or joint brokerage account and save as much as possible there.