Have Big Dreams? You May Need a Taxable Investment Account

There’s a lot of advice about saving and investing your money, but most of the advice I read advises readers to open tax-advantaged accounts.

Save in an IRA or a 401(k), and you reduce your taxes. Save in a Roth IRA, and you don’t pay taxes on the withdrawals when you retire. Save in a 529 Plan, and the money grows tax free until you have to pay for college.

I do all of those things. I have a traditional IRA and a Roth. Some years I invest in the Roth, some years in the traditional IRA. It just depends on our tax situation. Jon has retirement accounts, too. We even have a 529 plan for Little Bit.

We also have taxable investment accounts.

Why would I have taxable investment accounts with all of those other accounts in the world that reduce my taxes now or in the future? Aren’t I just paying extra taxes that I could otherwise avoid?

I could. I could have put all of my investment funds in IRAs and other tax advantaged accounts. Instead, I’m paying taxes each year on dividends and interest. Occasionally, I’m paying taxes on capital gains. If those investments were in a traditional IRA, I wouldn’t have that annual tax bill. If they were in a Roth, those investments would never have tax consequences again.

So yeah, I’m paying extra. Sometimes you have to pay extra to follow your dreams.

Opening My Taxable Investment Account

I started saving for retirement in my late 20s. Although I didn’t invest wisely or well, I did open a traditional IRA and fund it on a regular basis. I was paying off a car, credit card debt and some student loans on a just better than minimum wage job, so I didn’t put a lot each month: only $30. It was a start, and that was important at the time.

And then I got a raise.

And then I finally paid off that credit card debt that had been weighing me down for most of my 20s.

I had more to spend, more to put towards my other debts, and more to invest. Once I did a little math, I figured I had freed up an extra $100 a month to go toward investing.

In retrospect I could have saved more. Unfortunately, I prioritized buying new books and going out to eat as well as savings. At least I put savings in the mix.

I knew that eventually I would want to retire, and I needed to put money aside so that I could retire someday.

I also knew that there were other things I wanted to do in life. I wanted to own a home. I wanted to have a child, or maybe two or three. I wanted to travel. I maybe wanted to open my own bookstore, or go back to school.

I didn’t want to wait until I was retired to do those things. Maybe I would wait a few years before I’d act on them, but I had dreams to pursue into my 30s and 40s.

I could have just saved money in the bank, and I saved a little bit there. I put money in the bank to have a secure cushion against emergencies. The problem was that money in the bank is easily accessible and returns are low I didn’t put money in the bank to build wealth, I put it there to prevent poverty.

If you want your money to work for you, though, you can’t just put it in the bank. You need to invest it. I invested some of my money in tax-advantaged accounts for retirement because I want to save money for retirement. I didn’t want to tie up all of my investments until I reached a qualifying event, though, so I also opened a taxable investment account.

Have Big Dreams? You May Need a Taxable Investment

Flexibility Costs

In some ways, I’d had a taxable investment account for years even then. My mom had given me some Jefferson Pilot stock in my early 20s, and it had grown handsomely due to stock splits, dividend reinvestment, and stock appreciation. I’d paid taxes on the dividends for years, but had never sold a share or cashed a dividend check.

While I might raid my savings account to pay for a new computer or a car down payment, I never touched the investments. Even though there was no legal reason not to touch them, I left them alone. I was saving those investments for THE FUTURE, whatever that might mean.

I knew to leave alone my retirement savings as well. Retirement savings were for a very specific future. If I didn’t want to pay tax penalties and additional taxes, then retirement savings were going to stay safe in their account until I turned 59 and a half.

There are exceptions. You can raid your IRA without paying the penalties for certain things, like buying your first house. Tax-advantaged accounts have tax advantages for a reason, though, and those exceptions are limited.

Lawmakers have structured tax-advantaged accounts to promote certain behaviors, like saving money for retirement. They don’t really want you to deviate from that purpose. If you take money out for other purposes, whether it’s following a dream of traveling around the world or retiring before the norm, you’ll end up paying extra.

Not all of us want the same things, and I knew I might want to invest for something other than the standard retirement. That flexibility was going to cost, either through tax penalties or regular taxation. I chose a taxable investment account to give me the flexibility to follow other dreams too.

Reducing the Cost of Flexibility

There are ways that you can reduce the cost of investing in a taxable investment account. Like with any account, you want to keep your fees to a minimum. That means no high-cost mutual fund fees and no high cost accounts.

There’s also some tax strategies you can use to reduce the taxes you are paying on taxable accounts. I invest some of my funds in tax-free in-state municipal bonds, where interest is exempt from both federal and state income taxes. That means I receive the interest deposited into my account, but don’t have to pay income tax on it as I would for gains, dividends, or regular bonds. The interest rate isn’t terrific, but it’s better than what I’d earn in a bank account. I’d be paying taxes on bank account interest too, so the muni bond has some definite advantages.

Another strategy is to invest in growth stocks that pay minimal dividends or don’t pay dividends at all. Hopefully your stock choices will grow and you’ll only pay taxes on any gains when you sell the stock. Fortunately, tax law favors long term capital gains taxes with lower rates than ordinary income. You may end up paying very low taxes to hold your stock. To make this strategy work effectively, you’ll need to limit the amount of trading you or the fund you invest in do. Buy and hold means a lot fewer gains to manage than active trading. A good index fund or ETF usually fills the bill nicely.

Others use tax loss harvesting to offset gains, That means they sell some stocks at a loss (possibly rebuying the same stock or similar with the proceeds) to offset gains from other sales.

Funds to Follow All Your Dreams

I have a taxable investment account. I used it to put a down payment on my first house, and a larger down payment on my current house. I used it to pay some of the funds for my wedding. I used it to acquire rental property.

I used it to follow dreams, dreams that wouldn’t wait for another couple of decades when I could start drawing down my retirement accounts without penalty.

In no way am I saying don’t invest in traditional retirement savings. Please save. Most people won’t be able to work forever, and it’s good to put some money aside that isn’t easily accessible until you reach traditional retirement age.

But, maybe, like me, you have dreams that you intend to follow well before age 60. Maybe you don’t like the idea of tying up all of your investments for 40 or 20 or even 10 years.

Investing is not an all or nothing proposition. Save for retirement. Save for the future. But consider keeping some funds accessible so that you can follow your dreams without waiting. Consider putting some of your money in a taxable investment account.

Thanks to Amanda at Centsibly Rich. The conversation on her post Are you scared to invest? How to get past your fear and get started inspired this post!

Do you have a taxable investment account? If so, what inspired you to open it? How do you balance retirement and other investments?

Top Image courtesy of Feelart at FreeDigitalPhotos.net
*Part of Financially Savvy Saturdays on brokeGIRLrich and, Disease Called Debt*

12 thoughts on “Have Big Dreams? You May Need a Taxable Investment Account

  1. Thanks for the follow up to my post earlier this week! You are way ahead of me with the taxable accounts. We have focused the last 18 years on tax advantaged accounts and, though we have money in savings accounts, we missed out on some growth by not taking advantage of taxable accounts earlier. We are actually considering taking a portion of our savings and putting it into our taxable account (while continuing to max out our tax advantaged accounts).

    For those who want to retire early, but have the majority of their money tied up in retirement accounts (with the 59 1/2 distribution age), a couple of options to look into are the Roth IRA conversion ladder (income dependent) and a SEPP 72(t) distribution. We’ve looked at both and, although they could supplement an early retirement, additional savings in a taxable account would likely be necessary.

    Thanks for sharing, Emily!
    Amanda @ centsiblyrich recently posted…Are you scared to invest? How to get past your fear and get startedMy Profile

    • Yes, as a way to supplement savings, save for things other than retirement or college, or even saving for a flexible retirement date, taxable accounts make a lot of sense.

      Thanks for bringing up the Roth conversion ladder and SEPP 72(t) distributions. I am less familiar with those options but they both seem tricky, and work better for early retirement than following another dream.

    • So many people don’t have the appreciation for what their taxes do. You have a very refreshing point of view.

      (Personally, I’ve always said any taxes I pay go to the part of the budget that funds the Blue Ridge Parkway and my public library.)

  2. Absolutely I do invest in both tax advantaged and taxable accounts for all the same reasons. I’d like to retire early and there would be a gap between my age and the age minimum for distributions – invest! I’d like to grow our savings by more than 0.05% per year and that means investing. I want to draw a steady income not just from my work, and that means dividends. Buying and holding stocks for their growth and dividers is every bit or more as satisfying as buying things, and is a great curb on spending too. My motto when I get the urge is to buy assets instead of things.

    It’s not that I shun necessities, it’s just a far better redirection for my restlessness when I randomly feel the urge to buy things and don’t have much willpower: go ahead, buy (researched) stocks!
    Revanche @ A Gai Shan Life recently posted…Just a little (link) love: Tonys editionMy Profile

    • We would all do better if we shopped for more investments when we had the urge to buy something. I suppose that’s another argument for those who are afraid to invest: even mediocre investments will bring you more wealth than an extra pair of shoes or night on the town.

    • Early was good. i wish I’d done more.
      I am so bad about projecting our investment income. Some of this is because of our rentals: it’s hard to know how the related income will flow for tax purposes each year because repairs and vacancies come up unexpectedly. I could probably do a better job than I do with my interest, dividends and capital gains distributions though. (There’s a post there, I’m sure. Thanks for the idea.)

  3. I use my Roth as a taxable account. We put enough in our 401ks to fund our retirement, therefore the Roth is “extra”. If we have more than enough to max out both, then I might put money in a taxable but I won’t give up my tax advantage space for anything.

    • The Roth is a lot more flexible than a traditional IRA, though you still have to be careful about early withdrawal rules to avoid penalties if you decide to take money early (contributions only after 5 year, etc). You have to make your choices based on your goals and circumstances but saving, no matter how you do it, is never a bad choice.

  4. If we can get the IRA(s) maxed out, I will happily throw something in taxable investments too! But first, max out the Roth, open a SEP and fund the remaining amount. Then decide whether it’s a better idea to do regular investments or open an IRA for Tim.

    I used to think I’d have interesting dreams and goals. Instead, I dream of fully funded retirement accounts. Sigh.
    Abigail @ipickuppennies recently posted…Avoiding the “Oh well” mentalityMy Profile

    • One of the reasons I have taxable accounts is that my concerns were about more than retirement. If retirement is your main concern, then it might be better to fund an IRA for Tim and continue to take advantage of the tax benefits. You may even want to open a traditional IRA for him for a different benefit/structure than you have with your Roth.

      I think it’s good for both spouses to have their own retirement accounts, even if only one is working, because both are contributing to the household. In our case, it gives us some added flexibility too, because Jon is 8 years older than I am.

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