Benefits of Taxable Accounts
- Alex Potter, CFP®
- Mar 2
- 4 min read
Most people have a 401(k), 403(b), IRA, or Roth IRA. This is the most common way to save for retirement since most employers offer these plans. On average, people will have 10–12 jobs throughout their working careers, which often leads to rollover IRAs or Roth IRAs along the way. If you’re saving for retirement, it makes sense to use retirement accounts, right?
However, there is a powerful alternative that many individuals overlook.
I’m talking about an after-tax investment account. These are often titled as Individual, TOD (Transfer on Death), JTWROS (Joint with Rights of Survivorship), or held inside a Trust.
These after-tax savings vehicles carry unique tax advantages that retirement accounts don’t.
No Federal 10% penalty to access funds before age 59 1/2
Access to the account at any time
No required minimum distributions (RMDs)
No mandatory beneficiary “spend down” rules
(With pre-tax retirement assets, beneficiaries (spouse vs. non-spouse) must follow specific distribution rules.)
Taxes are either short-term capital gains or long-term capital gains
Upon death, heirs typically receive a step-up in cost basis
Qualified dividends may receive favorable tax treatment
Let’s focus on a few of these bullet points.
Taxation of after-tax accounts are unique and worth understanding.
When you invest, the custodian will keep track of your “cost basis” or put in plain english, how much you invested out of pocket.
Let’s say you invest $10,000 into Apple stock at $250 per share. You now own 40 shares.
A few months later, you sell those shares at $300.
40 shares × $300 = $12,000. That’s a $2,000 profit.
If you sold within 12 months, that profit is considered short-term capital gains (STCG). Short-term gains are taxed just like ordinary income. If you’re in the 22% bracket, you would owe $440 in federal tax.
Now here is the advantage of after-tax accounts.
If you hold the shares longer than 12 months before selling, the gain becomes long-term capital gains (LTCG).
Same $2,000 profit, but now it’s taxed at 0%, 15%, or 20%, depending on your total taxable income.
That difference in tax treatment can matter more than people realize.
Now let’s take a look at those tax brackets.
Single:
Married Filing Joint:
If you’re married and have $200,000 of taxable income, you would fall into the 15% long-term capital gains bracket. Using our example, a $2,000 gain would result in just $300 of federal tax.
That’s a meaningful difference simply by waiting 12 months before selling. For some households, the long-term capital gains rate can even be 0%.
Also remember, taxes only apply to gains when you actually sell. If you don’t sell, there is no capital gains tax due.
And each time you buy additional shares, the 12-month clock starts over on that specific lot.
But wait… there’s more.
Tax loss harvesting is another unique feature that retirement accounts simply don’t have. The IRS allows you to use up to $3,000 per year in capital losses to offset ordinary taxable income.
Using the same example, let’s say your $10,000 investment in Apple is now worth $7,000. If you sell and realize the loss, you now have a $3,000 capital loss.
That $3,000 can reduce your taxable income. If a married couple is in the 22% marginal bracket, that could mean $660 in federal tax savings.
There are no tax loss harvesting opportunities inside pre-tax accounts like a 401(k), 403(b), or IRA.
If your losses exceed $3,000, the IRS allows you to carry those losses forward indefinitely to use in future years. This can be a powerful long-term tax planning tool.
Tax loss harvesting can get complicated quickly. There are “wash sale” rules to be aware of so your losses are not disallowed. That’s why it’s important to work with a professional if you want to do this correctly.
For this newsletter, we won’t go deep into the weeds but the main point is that after-tax accounts can provide real tax flexibility when used properly.
Next, let’s talk about what a “step-up in basis” means.
Perhaps one of the biggest advantages of an after-tax investment account shows up at death.
Let’s say you build an after-tax portfolio that is worth $200,000 when you pass away. Of that $200,000, your original cost basis is $100,000.
That means there is $100,000 of unrealized gain.
Here’s the key: your beneficiary receives a step-up in basis.
In simple terms, the IRS resets the value to $200,000 as of the date of death. The $100,000 of gain disappears for tax purposes. Your heir now owns the account as if they started at $200,000. Amazing.
If they sell immediately, there may be little to no capital gains tax owed. If they continue investing, their short-term or long-term capital gains clock starts from that new stepped-up value.
Call it a “loophole” if you want, but it’s a legal method to avoid taxes.
Anyone have a Great Uncle that might leave an inheritance? Better hope it’s an after-tax account and not an IRA!
For families focused on building and transferring wealth, this step-up feature alone can make after-tax investing extremely attractive.
Once again, there are nuances and special rules that can get technical. But at a high level, after-tax accounts offer significant tax advantages when structured properly.
Any savings is good savings. Compound growth works no matter how you invest.
However, if you want to take your investing and tax planning to the next level, building an after-tax portfolio could be a smart move.
If you’d like to discuss how this type of account might fit into your situation, please reach out to our team. Everyone’s circumstances are different, so this strategy may or may not make sense for you. But if you don’t currently have an after-tax portfolio, it may be worth considering.
If you have questions or want to explore this further, we’re here to help.
And for those who made it all the way through this, congratulations! This was a long one.
Financial Fact
By the late 1970s, the top capital gains bracket reached 35%!
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. This communication is strictly intended for individuals residing in the states of MI, IN, OH. Cambridge and Foundation Wealth Management are not affiliated.
