Wednesday, 29 March 2023

Why Dave Ramsey Says There’s a Huge Drawback to Taxable Investment Accounts

by Earn Media

<div>Why Dave Ramsey Says There's a Huge Drawback to Taxable Investment Accounts</div>

Image source: Getty Images

When you’re saving for a far-off goal like retirement, you may have different options for investing your money. You could open a traditional IRA and get a tax break on the money you put in. Or, you could open a Roth IRA and get a tax break on your investment gains and the money you take out.

Another option is to simply invest your money in a regular brokerage account. But if you ask Dave Ramsey, that might be a mistake.

A mixed bag

Taxable investment accounts, like regular brokerage accounts, have their benefits. These accounts give you complete control over your money. There are no annual contribution limits you need to pay attention to, and you can cash out your investments and withdraw funds from your brokerage account at any time without penalty.

Now, this doesn’t mean you can withdraw funds at any time without taking a loss. If you invest $10,000 and the market tanks, leaving you with $8,000, cashing out completely will mean losing $2,000. The point, however, is that your account itself won’t come with rules that restrict what you’re able to do.

IRAs, on the other hand, penalize you for withdrawing funds prior to age 59 1/2. And there are annual contribution limits that change yearly you need to stick to.

But while taxable investment accounts give you more flexibility, you lose a very key feature — tax breaks. And that could be costly.

Let’s say you decide to invest $5,000 in a traditional IRA. If you put that money into an account this year, the IRS won’t tax you on $5,000 of your 2023 income. That’s a pretty neat deal. But if you put $5,000 into a regular brokerage account, there’s no tax benefit to reap at all.

Now, let’s say you decide to put $5,000 into a Roth IRA this year. That won’t exempt any of your 2023 income from taxes. But, let’s say that over time, your Roth IRA balance grows from $5,000 to $10,000, not because you’ve added money, but because you’ve been a savvy investor. In retirement, you can withdraw your $10,000 tax-free, and you won’t pay taxes on that $5,000 in gains.

By contrast, let’s say you invest $5,000 in a taxable brokerage account and it grows to $10,000. You’ll be liable for capital gains taxes on your $5,000 profit. And, depending on how long you’ve held your investments, your capital gains tax rate could end up replicating your ordinary income tax rate. This will apply if you sell investments before having held them for a year and a day.

Don’t pass up a chance to save on taxes

Taxes can be a huge burden — both during your working years and during retirement. While there are benefits to investing in a regular brokerage account, losing out on tax breaks could mean burdening yourself with a higher IRS liability.

If you want to retain some flexibility with your money, consider dividing your investment dollars between a tax-advantaged retirement plan and a regular brokerage account. That should give you the best of both worlds.

Our best stock brokers

We pored over the data and user reviews to find the select rare picks that landed a spot on our list of the best stock brokers. Some of these best-in-class picks pack in valuable perks, including $0 stock and ETF commissions. Get started and review our best stock brokers.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.