Considering Using a Non-Qualified Account to Save for Retirement?

There is a certain investing app (I’m not naming names) that has become pretty popular lately. I have no opinion to express on its merits but I do want to use it as an entry point to talk about the logic, or perhaps the lack thereof, of investing for the long term outside of your retirement account.

Here is the bottom line up front: If you are investing for your retirement, until you have completely exhausted all of your options to invest within a tax-advantaged retirement account, it makes little sense to invest for this purpose using a taxable brokerage account, as one would do if they were investing through the above referenced app.

When you complete your tax return, this point will become very real to you. Let me introduce you to IRS Form 1040 Line 3b and Schedule D. This is where you will report your income from dividends and capital gains from your investments that are outside of your retirement account(s). And then you will write a check (figuratively) to pay taxes on that amount. When you made that investment, was this for the purpose of funding your retirement? And if so, could you have just as easily made the same or similar investment within the arms of your workplace retirement plan or an IRA? If yes, then you would have avoided writing that check to the IRS. 

You can save up to $19,500 annually in most workplace retirement accounts (if you have one) and, in addition, $6,000 in an Individual Retirement Account (IRA) outside of your workplace. If you are self-employed, you have other retirement account options. It is only after crossing that threshold when investing for retirement in a taxable account makes sense. (You can also save for retirement in a tax-advantaged way by using a Health Savings Account (HSA)). The more money that stays in your retirement account, through deferred or avoided taxes, the more there is available for compounding returns.

Let me bring a bit of math to the table. If you made a one-time investment of $6,000 for 20 years at 8%, your end result would be $20,133 if you made that investment within a taxable account (22% tax bracket)…or $27,966 if you made the same investment within a Roth IRA or Roth 401(k).

Now there is a scenario where power-funding your retirement outside of a 401(k) or IRA makes a lot of sense. If you plan to retire before the age of 59 ½, you will want to invest a portion in a regular, taxable account so that you can access part of your nest egg early, without penalty.

I get that using an app to put a little money “in play” is way more fun than filling out a form from your company HR department to up your 401(k) withholding. But do you really want to pay for that fun through a higher tax bill today and a lower return in the future?

Financial Guide

Lisa W.

Accredited Financial Counselor®

Chartered Retirement Planning Counselor℠

I love being a Financial Guide because I enjoy making the seemingly complex simple. It's tremendous fun to help someone solve a financial planning puzzle.