If you’re a Baby Boomer or older Gen Xer with adult children, it’s likely that your kids’ finances are tighter today than they will be for much of the rest of their lives. Typically, income matches expenses, and finances may even cross into the red when you have young children and are paying daycare expenses. As your career progresses and your kids get older, you should have more opportunities to save. The gap between income and expenses is often biggest between when your kids finish college and when you retire. I can see you on the other side of the screen nodding your head in agreement.
That window between your kids fleeing the nest and your retirement is when you should see the biggest growth in your balance sheet and, more specifically, your retirement accounts. However, the retirees with the most flexibility also use taxable or non-retirement accounts. These accounts carry an array of labels: joint account, individual account, taxable account, brokerage account, living trust account, etc. But they all mean the same thing from a tax perspective: You are paying capital gains taxes as you transact rather than paying income taxes when you withdraw.
While taxable accounts tend to grow more slowly than their equivalent tax-deferred counterparts, they offer three significant advantages.
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1. Low post-retirement tax rates
If you have saved enough in your taxable accounts to fund several years of expenses, you will find yourself in a low tax bracket in the early years of retirement. That’s a nice reprieve from the rates you were paying during your peak earnings years.
Additionally, it will allow you to convert funds from pre-tax accounts to Roth accounts at a lower rate than you will face in the future. If you drop into the 12% marginal tax bracket, or below, your capital gains bracket will also go to zero.
Much of this planning has to do with comparing current tax rates to future tax rates. The best planning software will project this out for you. You can try a free version of ours here.
2. Flexibility
Sometimes when I sit back and think about 30-year projections, as only a financial planner would, I realize just how silly it can be. Can you imagine thinking about where you will be at 40 when you’re 10? However, this is the best tool we have to ensure that you don’t run out of money. The reality is that many things can and will come up that you haven’t planned for. We’ve got clients with houses that were destroyed this hurricane season. We’ve got clients who are paying for their kid’s second wedding. We had clients move south during Covid, only to realize they didn’t like it, and sell their new home. The point is that life is dynamic. A taxable account helps protect you from unpredictable events.
Every time you withdraw from a retirement account, you are electing some withholding rate. Unfortunately, most people are just guessing what it is. A taxable account doesn’t require that same level of planning. Of course, you will have capital gains when you sell an investment, but you don’t have to calculate that every time you take a withdrawal.
3. Tax-friendlier than you thought for you and for your kids
Capital gains rates are lower than income tax rates in order to encourage investment. Most folks will pay a 15% capital gains tax plus whatever your state charges. This can be an incredibly tax-efficient way to invest if you invest in low-cost indexes that do not trade often and, therefore, are not kicking off capital gains as your investments grow. You can also invest in growth companies, which tend to pay smaller dividends to lower the tax blow along the way. Lastly, this is where municipal bonds can play a role in your investment strategy.
We often think of Roth IRAs as the best vehicle to leave to kids, and they probably are, but taxable accounts are close. Taxable accounts receive a “step-up in basis” at death.
Example: You buy $100,000 of Apple (APPL) stock. By the time you die, it’s worth $750,000. Your kids can sell that $750,000 without paying any taxes. They will pay capital gains taxes only on the amount of gain that accrues after your death.
This article is by no means a warning against saving into your retirement accounts, as is the practice of today’s permanent life insurance salesman; it is about the benefits of spreading out your savings. That way, when your friends ask if you want to go to Italy, you’re not thinking about tax withholding before saying “yes.”
Related Content
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- How the IRS Taxes Retirement Income
- Five Changes Coming to IRAs and 401(k)s in 2025
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