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.
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?