How a Taxable Brokerage Account Can Be Better Than 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.

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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.

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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.

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. This type of non-qualified (non-tax-advantaged account) is commonly referred to as a taxable account, which sounds like a terrible place to invest.

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 (assets held > one year) capital gains and qualified dividends are typically taxed, as well, but at a preferential capital gains rate.

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