You’re doing everything you should be doing, or so you think. You’ve been pouring savings into traditional IRAs and 401k’s, lured by tax-deferred growth.
It’s a solid strategy—contribute pre-tax dollars, watch your investments compound without Uncle Sam skimming off the top each year. But here’s the twist: What if I told you that for certain investors, a plain-vanilla taxable brokerage account could deliver better after-tax returns, especially if you’re holding high-growth assets? Let’s learn why this might be your secret weapon for tax-smart wealth building, and how it supercharges your legacy for your heirs.
First, the basics: In a traditional IRA or 401(k), withdrawals in retirement are taxed as ordinary income (vs. long-term capital gains rates), hitting rates as high as 37%. That’s right, retirement accounts get clobbered at potentially sky-high marginal rates when you start drawing down.
Contrast that with a taxable brokerage account: You fund it with after-tax dollars, but long-term capital gains on assets held over a year are taxed at just 0%, 15%, or 20%—far gentler than ordinary income. Plus, if your investments are growth-oriented stocks or funds that rarely spit out dividends (think tech giants like pre-dividend Amazon), you pay zilch on unrealized appreciation. The account balloons tax-free until you sell, at which point only the gain—not the principal—is taxed at those preferential rates.
In addition, no forced distributions via Required Minimum Distributions (RMDs) starting at age 73 with IRAs and 401k’s. You control the timing of sales, harvesting gains in low-income years.
And it gets even better…at least for your heirs. Brokerage accounts offer a “step-up in basis” at death: Assets reset to their fair market value on the date you pass, erasing all pre-death gains for tax purposes. If your heirs sell immediately after your passing? Zero capital gains tax. Hold and grow? Only future appreciation is taxed at LTCG rates.
Traditional IRAs and 401k’s, no such luck, your heirs inherit the full tax-deferred bomb, with distributions taxed as ordinary income AND post-SECURE Act, non-spouse beneficiaries must empty the account within 10 years, triggering a decade of taxable withdrawals that could spike their brackets. Brokerage accounts have no 10-year clock. Heirs can hold indefinitely, letting tax-efficient compounding continue for generations.
Scenario: Meet Sabrina, a 67-year-old retiree with $4 million split evenly between a traditional IRA and a taxable brokerage. Both are invested in high-growth investments with minimal dividends (say, 0.5% annually). Over 20 years, both portfolios grew to $2 million. Sabrina needs $100,000 yearly in withdrawals.
From the IRA: That $100,000 is considered ordinary income for tax purposes. Assuming she’s in the 22% bracket (taxable income around $130,000 including Social Security), she forks over $22,000 in federal taxes. After 10 years, she’s withdrawn $1,000,000 and paid about $220,000 in taxes, leaving her portfolio lighter by that drag. Fast-forward: Sabrina passes at 77, with $1,000,000 left. Her kids must drain the account within 10 years, paying taxes at their tax rate on every dollar taken out. If they sold all of it immediately, they’d pay a 37% marginal tax rate on the $1,000,000 withdrawn.
Flip to the Brokerage account: She sells $100,000 worth of shares annually. Her original cost basis is $1,000,000, so each sale triggers roughly $50,000 in gains (proportional growth). At a 15% long-term tax rate, that’s just $7,500 in taxes per withdrawal. Over 10 years? $75,000 in taxes, saving her nearly $145,000 compared to the IRA. And no RMDs means she can let the account compound longer if she’d like. Upon her death, the remaining $1,000,000 gets a step-up: Kids inherit at current value, meaning if they sell immediately, they will pay $0 taxes, keeping all $1,000,000. Result: hundreds of thousands of dollars saved.
Of course, this isn’t a one-size-fits-all. For those with growth-heavy portfolios and flexible withdrawal needs, the taxable brokerage account can provide lower tax rates, increased distribution control, and heir-friendly features that can supercharge your legacy.
It’s not just about asset allocation; it’s also about asset location.
-Paul R. Rossi, CFA