When beginning to explore investing, the first thing that often comes to mind is retirement accounts like an IRA or 401(k). While these accounts are great for long-term savings and offer tax benefits, they’re not the only way to invest. Enter taxable investment accounts—a flexible way to invest money without the tax advantages of retirement accounts, but with more freedom in how and when you access your money. If you’re wondering what taxable investment accounts are and whether you should consider one, we’ve got the answers!
Taxable Investment Accounts vs. Retirement Accounts: What’s the Difference?
So, what’s the difference between a taxable investment account and a retirement account? Both are ways to invest your money, but there are key distinctions.
Retirement Accounts (like IRAs and 401(k)s): These accounts are designed for long-term saving and come with specific tax advantages. With traditional accounts, you defer taxes on the money you contribute until you retire. In contrast, Roth accounts allow you to pay taxes upfront and enjoy tax-free growth. The catch? You generally can’t access the money until retirement age without facing penalties.
Taxable Investment Accounts: These accounts are much more flexible. You can invest money in stocks, bonds, mutual funds, ETFs, and more, just like you can in retirement accounts. The main difference is that taxable accounts don’t offer the same tax perks as retirement accounts. Instead, you’ll pay taxes on your gains as you make money, which can be either capital gains or ordinary income tax, depending on how long you hold your investments.
How Taxes Work in a Taxable Investment Account
When you invest in a taxable account, you’re responsible for paying taxes on any profits you make. The type of tax you pay depends on how long you hold your investments:
- Short-Term Gains: If you sell an investment after holding it for one year or less, the profits are taxed as ordinary income. This means you’ll pay the same tax rate as you do on your regular income, which can be higher than capital gains taxes.
- Long-Term Gains: If you hold your investment for more than one year, the profits are taxed at the capital gains tax rate, which is generally lower than ordinary income tax rates. This is one of the biggest advantages of taxable accounts, as it rewards long-term investors.
The tax treatment of your investment gains can significantly impact your overall return, so understanding these tax rules is key to making the most out of your taxable investment account.
Should You Open a Taxable Investment Account?
You may be wondering if a taxable brokerage account is the right move for you. If you’re already saving for retirement through accounts like IRAs or 401(k)s but want to invest without waiting for retirement age to access your money, a taxable investment account might be a great option. Here are some reasons to consider it:
- Flexibility: Unlike retirement accounts, there are no withdrawal restrictions with taxable accounts. If you want to access your funds before retirement, you can do so without penalties.
- Tax Diversification: Having both retirement accounts and taxable accounts gives you a mix of tax treatments. This can help you create a more efficient investment strategy for the long term.
- Higher Contribution Limits: There are no contribution limits for taxable accounts, unlike retirement accounts, which can be restrictive in terms of how much you can contribute annually.
However, you’ll need to balance your investment strategy. It’s important to first prioritize maximizing your retirement account contributions, especially if your employer offers a match. Once you’ve maxed out your retirement savings, you can consider putting additional money into a taxable investment account.
When Should You Work With a CERTIFIED FINANCIAL PLANNER™?
Managing taxable investment accounts can get tricky—especially when it comes to tax implications. If you plan on buying and selling investments frequently, or if you’re looking to optimize your tax strategy, working with a CERTIFIED FINANCIAL PLANNER™ (CFP®) is highly recommended. A CFP® can help you determine the best account types for your goals, as well as help you manage taxes on your investments, ensuring you’re not hit with unexpected tax bills.
Additionally, if you’re considering day trading or making high-frequency trades, a financial planner can guide you on how to handle those transactions in a tax-efficient way.
Pros and Cons of Taxable Investment Accounts
As with any financial decision, taxable investment accounts come with both benefits and drawbacks. Here’s a quick breakdown:
Pros:
- No Withdrawal Restrictions: You can access your money at any time without penalty.
- Tax Diversification: Having both taxable and tax-advantaged accounts gives you flexibility in managing your taxes.
- No Contribution Limits: You can invest as much as you want in these accounts.
Cons:
- Taxes on Earnings: You’ll need to pay taxes on any gains, whether short-term (higher tax rate) or long-term (lower tax rate).
- No Tax Deferral: Unlike retirement accounts, you don’t get tax-deferred growth, meaning you’ll pay taxes annually on your gains.
Is a Taxable Investment Account Right for You?
Whether a taxable investment account makes sense for you depends on your goals and financial situation. If you’re looking for flexibility and don’t want to wait until retirement to access your investments, a taxable account could be a smart move. Just be sure to consider the tax implications and make sure you’ve already maxed out any retirement savings options first.
Working with a CERTIFIED FINANCIAL PLANNER™ can help ensure that you’re using taxable accounts in a way that aligns with your long-term financial strategy.