There are many reasons why people choose to invest in a taxable account. I named two big reasons in my previous post.
Here are five more in case you needed a little more convincing.
- Investment account diversification: the idea is that you can minimize taxes by withdrawing money from various types of accounts. For example, if you need about $100,000 a year in retirement, you can withdraw from your Roth, Taxable and 401k accounts to sum up to $100,000. And if you do your calculations right, you can pay $0 in taxes every year and make your nest egg last your entire retirement. I wrote a paragraph on it at the end of this post if you are interested. It is not difficult to keep your taxes in a single digit percentage in retirement, but it does require a lot of planning to keep it at 0%.
- Tax deduction on capital losses: this concept is critical to the use of a taxable investment account. The idea is that when you sell your securities at a market downturn (which you shouldn’t do unless you know what you are doing), your net loss can be tax deductible up to $3000 against your gains in a year. (Thanks to my reader Zeb Rasco for catching my initial mistake there.) If your net loss exceeded the per year maximum, the leftover can be carried forward to subsequent year or years.
- Tax Loss Harvesting: Building on point 2 but even better. If you sold a fund at a market downturn, claimed the capital losses ($3000 a year and carry forward in the years after on your taxes), AND buy back into the market in an asset that is NOT “substantially identical”, you essentially have not changed your market exposure or investment cash flow! Let me break this concept down in another post specifically addressing tax loss harvesting (TLH) and “wash-sell rules”.
- Step-up in basis at death for estate planning: a really cool trick that people don’t use enough. If you buy stocks in your taxable account and held it all your life and let’s say you decided to sell it before you die, you are going to own a huge quantity of long term capital gains tax. However, instead of selling it, you leave it in your account and your heir sells it after you die, they don’t pay a dime on the capital gains from your initial investment price. It is a crazy rule but very useful for your estate planning.
- Charitable donations: I put this reason last as very few people actually take advantage of it but it is a very useful tool for generous people in our society. Let’s assume you are interested in donating $10,000 to a charity. Instead of donating out of your bank account, you look in your investment account. You noticed 25 shares of a stock fund you bought 20 years ago for $2,500 is now worth $10,000. If you donate these 25 shares fund to a charity, you will find three tax advantages:
- You get tax deduction for your charity donation;
- You don’t pay any taxes on the capital gains ($7500 donation tax free);
- The charity receiving your donation doesn’t pay any tax on your stock fund donation.
There are many other advantages of investing in a taxable account. With all that said, I personally believe the investment account priority should be: 1. HSA; 2. traditional 401k; 3. Backdoor Roth IRA; 4. Taxable account. If you are able to max out on the first three accounts, only then you should invest the rest of your money in a taxable account.
However, for a high income individual who maxed out 401k, IRAs and various other tax sheltered investment options, you may not have any other choice but to invest in a taxable account. But don’t feel like you are getting jibbed by investing in a taxable account.
As I have illustrated in this post and my previous post, I don’t think it’s a disadvantage at all to invest in taxable accounts, especially if you invest for a long time. The key to wealth accumulation is to invest regularly and prudently for a long time.
What do you think? Do you put money in your taxable accounts? Can you think of any other advantages of investing in a taxable account? I can actually think two more but I’m afraid this post may get too long. Let’s talk about it if you are interested. Leave me a comment below!
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