How a Taxable Brokerage Account Can Be as Good or Better Than a Roth IRA

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Would you believe that a non-qualified brokerage account, a.k.a. taxable account could mimic the benefits of a Roth IRA? Or be as good or better than a Roth 401(k)?

If you answered “no,” then I’ve got news for you, and if you answered “yes,” then I probably don’t have much to teach you and you’re welcome to move on over to Bogleheads and answer everyone’s questions over there.

A certain number of conditions must be met, of course, and it may not be ideal to attempt to meet all of the criteria, but the fact is that a taxable account can behave pretty much exactly like a Roth IRA, but without some of the Roth IRA’s limitations, particularly after retirement.

What is a Roth IRA?

A Roth IRA is an Individual Retirement Arrangement that is funded with post-tax money. That is, you’re investing in the account with money that has already been taxed or you’re paying tax on the money when you convert it from tax-deferred to Roth.

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Growth in your Roth account is not subject to tax. Neither are withdrawals. Dividends are not taxed. Earnings are tax-free. Quite simply, once your money is in a Roth account, it will never be taxed again. Sure, the tax laws could change, but any proposal that resulted in double taxation of Roth money would be extremely unpopular and unlikely to gain real traction.

Limitations of a Roth IRA

Roth money is so valuable that most people, including me, recommend not touching it unless you have no other money sources available. Generally, taxable dollars and tax-deferred dollars should be spent first in retirement, and it can be smart to convert tax-deferred dollars to Roth, depending on your marginal income tax bracket.

What is a Taxable Account?

When you buy mutual funds, ETFs, or individual stocks or bonds outside of your tax-advantaged retirement accounts with your own hard-earned after-tax dollars, they will reside in a plain old brokerage account.

Limitations of a Taxable Account

The limitations are all about the taxes. Short-term capital gains and ordinary, non-qualified dividends are taxed at your marginal income tax rate. Long-term (held > one year) capital gains and qualified dividends are typically taxed, as well, but at a preferential capital gains rate.

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