What should you do after maxing out your retirement accounts?
Mostly everyone reading this article is contributing to at least one retirement account, at least if you are employed or own a business. Some retirement accounts allow you a current income tax deduction or a tax-deferred account contribution (IRA's, 401k's, 403b's, 457b's, and defined benefit plans). When you begin taking distributions from these accounts, you will pay income taxes at your top marginal tax rate. Hopefully that day will not come before retirement and (even more hopefully), our politicians will see to it that you are in a lower tax bracket during retirement. (Of course, as we've seen in the 2016 election cycle, nothing is predictable about politicians.)
Other retirement accounts, chiefly Roth IRAs, don't allow a current deduction, but are totally tax free when you are ready to begin taking distributions at age 59.5. Having a sizeable Roth IRA is a good estate planning move because the IRS does not require you to begin emptying your Roth over your lifetime, as you are required to do with traditional retirement accounts. This allows you to leave a tax-free "gift" to your heirs if you choose not to spend it all during your lifetime.
But what we often overlook is that a retirement account doesn't have to be blessed by the IRS to be used for retirement. In fact, I believe that taxable retirement accounts are ignored because we are so focused on "authentic" (IRS-approved) retirement accounts. Everybody should supplement their savings with a taxable retirement account, in my opinion. That may sound like heresy from a CPA and CFP, but please hear me out.
First of all, what do I mean by a "taxable retirement account"? All I'm referring to is a plain old investment portfolio that is not linked to any government regulations and that you are buidling for retirement. Sounds kind of boring but I am a big believer that the more boring your finances are, the more money you tend to have. Some of the benefits of a taxable retirement account are:
1. You have complete liberty over investments. You can use any fund family you desire, with any expense ratios, and any fund manager. In other words, you are not limited to the deal your employer made with your 401k provider.
2. You have complete flexibility over your account. You can take money out before age 59.5 without penalty, you can add more than $18k per year to your portfolio, and you don't have to account to anyone but yourself if you need to use the money in your account for any reason.
3. You can pledge your portfolio as collateral for a loan.
4. You don't have to begin emptying your taxable account when you turn age 70
5. You have "basis" in your account - when you take money out, you pay taxes only on the growth.
6. You pay a top tax rate of 20% on long-term capital gains and qualified dividends (from stock held for at least one year). This is about half of the current top tax bracket of 39.6% and over half if you take an early distribution and pay a 10% penalty for early withdrawal.
7. You get to write off capital losses in the account.
8. You can use income from the account to offset an unused investment interest deduction
9. Your heirs get a stepped-up basis if they inherit the account from you.
10. Your heirs don't have to begin taking withdrawals from the account when they inherit it from you.
Of course, taxable accounts can be problematic: money invested is not protected in the event of a lawsuit and you get basis instead of a tax deduction. That must be considered in the context of your goals and insurance protection in place.
Am I saying that having a taxable account is your top priority when saving for retirement? Not at all, but it may be near the top, depending upon where you are on your financial journey and the integration of tax planning with your short- and long-term financial goals. A taxable retirement account can be the perfect filler to some of the gaps in your tax and retirement planning strategy. Be sure to discuss incorporating one into your financial plans the next time you meet with your financial planner.