Are you saving for retirement? Do you invest all your money in retirement accounts such as a 401(k) or IRA? There is also a place in your savings for a taxable brokerage account provided you place the correct assets in the taxable accounts. Everyone should contribute to a company sponsored 401(k) if the company provides a matching program. If yours has a matching program that is free money and you should never shy away from an instant return. Regardless of anything else always contribute up to the company match even if your plan does not have the best investment options. After you contribute up to the match I recommend contributing up to the limit in a ROTH IRA if you qualify for one. I may be taking a negative outlook on things but I do not see the tax rates going down in the future. Depending on the asset it makes sense to keep taxable bonds, bond funds, equities that pay high dividends and REIT’s as in many instances their dividends are taxed as ordinary income.
Other advantages of a taxable brokerage account is there is no penalty if you were to need to the money before you retired or age 59 ½. In the event you withdrew the money from a retirement account prior to the age of 59 ½ you would not only pay taxes on the money but you will get hit with a 10% early withdrawal penalty. Another consideration is 401(k) plans and traditional IRA will have mandatory withdrawals at age 70 ½ regardless of if you need the money or not. And if you did not take the mandatory minimum withdrawal you are looking at a 50% penalty on what you should have withdrawn.
So what do you want to keep in a taxable account? Assets that have a tax benefit unlike those mentioned above. Municipal bonds are not taxed at the federal level and if you buy a bond or a bond fund that is comprised of bonds issued in your state of residence they are state income tax free as well. However the AMT tax may still apply even on nontaxable municipal bonds so when in doubt seek the advice of a financial planner or tax expert.
Individual stocks that you intend to own for over a year are a good asset for a taxable account. Provided you own the stock for at least twelve full months the gains are treated as long-term capital gains and taxed at 15% if your income is high and cold be zero for lower income households. In most cases capital gains will be a lower tax rate than your ordinary income. This approach can also be used for tax efficient ETF’s and mutual funds as well as the capital gains rule applies to them as well with the big exception that you will pay taxes regardless of if you reinvest the funds or take the distribution in cash. It is only a benefit to own ETF’s and mutual funds if they limit dividends and capital gains to a minimum.
While everyone needs to save for retirement a taxable account does have a place in anyone’s plan. Depending on the asset will determine where it should be placed. However, do not let taxes alone dictate your investments as all retirement and savings are considered a good thing. But if possible limit the amount that you will have to pay in taxes.
