What are taxable accounts?

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Taxable accounts are a type of investment account where you can buy and sell investments, such as stocks, ETFs, mutual funds, bonds, and other supported securities.

Contributions to a taxable account are made with after tax money and when you sell an asset in a taxable account, the profit (or loss) is listed in the capital gains section of your annual tax return. As the name suggests, profits are taxable when you use a taxable account.

Unlike tax-advantaged accounts (such as a 401k or IRA), taxable accounts do not have restrictions on how much you can deposit or when you can withdraw the funds.

The Short Version

  • Taxable accounts are investment accounts with no tax benefits from the IRS
  • Capital gains are subject to taxes when you earn a profit in a taxable account
  • No contribution limits or withdrawal restrictions
  • IRA, Roth IRA, SEP, and other brokerage accounts offer potential tax savings compared to a taxable account

What Are Taxable Accounts?

Taxable accounts are investment accounts where your profits are subject to taxation upon the sale of the security. There are no limitations on how much you can deposit into the account or when you can withdraw the money.

The best taxable accounts come with no recurring fees and give you access to all major US stocks, bonds, funds, and possibly more. Additional features may include options trading, foreign exchange, cryptocurrencies, futures, certificates of deposit (CDs), and anything else your chosen brokerage offers.

Types Of Taxable Accounts

Taxable accounts come from traditional brokerage firms and modern robo advisors. Each has pros and cons to consider.

>Traditional Brokerage Accounts

Traditional brokerage accounts are self-directed investment accounts where you choose your holdings. Traditional taxable accounts are generally the most cost-effective if you feel comfortable researching stocks, ETFs, and other investments ideal for your goals.

After a recent race to the bottom for brokerage fees, most firms allow you to trade stocks and ETFs with no commissions, and fees for other assets have also been on a downward trend.

Here’s our list of online brokers and how they compare.

>Robo Advisors

Robo advisors are automated investment platforms where a computer assigns you to a portfolio ideal for your long-term financial goals. When signing up, you’ll typically complete a short questionnaire discussing your age, current investments, financial goals, and risk tolerance. Based on those answers, your funds are assigned to a professionally designed portfolio aligned with your objectives.

Robo advisors generally charge a modest annual fee based on the size of your portfolio. Some brokerage firms, including M1 Finance, SoFi, and Charles Schwab, offer robo advising for free. Others, such as Betterment and Personal Capital, charge around 0.25% to 1% per year, depending on your portfolio.

>>>Related: Best Robo Advisors

How Are Taxable Accounts Taxed?

The taxes owed vary depending on how long you hold the specific investment and your income.

If you hold an asset for one year or longer, it is considered a long-term capital gain. In 2023, the tax rate here is 0% for filers earning up to $44,625 per year when single or $89,250 when married and filing jointly. The rate is 15% for long-term gains when you earn from those levels up to $492,300 when single or $553,850 when filing jointly. With a higher income, you pay 20%.

For short-term capital gains, profits are taxed as regular income. So you’ll pay your normal income tax rate.

Capital losses can offset capital gains, so if you earn $1,000 from one investment and lose $500 on another, your taxes would be based on the $500 total gain. Taxes can get complicated on investments, so use quality tax filing software or work with a trusted accountant to create an accurate tax return.

>Taxable vs. Tax-Advantaged Accounts

The big difference between taxable and tax-advantaged accounts is, surprise, how they are taxed – but also in how much you can contribute

Tax advantages can come at two times – once when money is contributed to the account and once when money is withdrawn from the account.

Traditional IRAs, traditional 401(k)s, and most other retirement accounts get a tax break when money is contributed. It is contributed pre-tax, which means that deposits you make to the account are not taxable in the year of the contribution. For example, if you contribute in 2023, your 2023 taxable income would be lower by the amount you contribute, assuming you make only qualified contributions.

Roth IRAs and other Roth-designates receive their tax break upon withdrawal of the funds. Contributions are made “after-tax”, which means that you don’t receive a deduction in income from contributing to Roth accounts but you’ll pay no taxes when you make qualified withdrawals, even on the growth.

Some accounts, such as the Health Savings Account, actually receive a tax break on both contributions and qualified withdrawals.

Of course, if you are getting some tax advantage you can expect some rules around the account. There are rules for each tax advantaged account stating how much you can contribute each year and when you can withdraw the funds. There are even income limits that apply which may make you ineligible for tax breaks if your income is too high. Each type of account has its own set of rules.

Taxable accounts, however, do not receive any tax breaks. Contributions are made after tax and taxes are due on any growth upon withdrawal. Since you aren’t getting any tax benefits there aren’t rules around how much you can invest or when you can withdraw your funds, so they are much more flexible in that regard.

Here’s a closer look at how to handle pre-tax and after-tax contributions.

Are There Advantages To Opening A Taxable Account?

Why would you want a taxable account when you can save on taxes with an IRA? There are plenty of reasons. Taxable accounts have several advantages over tax-advantaged accounts.

First, taxable accounts are extremely flexible. You can deposit and withdraw at any time. You can deposit as much as you want with no limits, a restriction you run into with tax-advantaged accounts.

Account holders are not subject to time bounds of how long they keep cash or specific investments in their account (although some mutual funds charge fees for selling quickly). Your taxes change depending on the holding period, but you can buy and sell any business day of the year. You can also contribute no matter what your income level.

Part of that flexibility means you can withdraw during early retirement. With tax-advantaged accounts, early withdrawals are subject to taxes and additional penalties. You don’t have to worry about tax penalties with a taxable account.

When Should You Open A Taxable Account?

For most people taxable accounts come into play after they have taken full advantage of their retirement accounts.

If you are maxing out your employer provided retirement account and an IRA and still have money to invest (good for you!) then a taxable account makes sense.

Another time to consider a taxable account is when you will need access to the funds before a traditional retirement date. All tax advantaged accounts have rules surrounding withdrawing the funds, retirement accounts tie withdrawals to your age, so if you will need the money before you retire you’ll want to put it in a taxable account.

Should People Prioritize Their Tax-Advantaged Accounts First?

Some investors are hesitant to invest in a taxable account when they have tax-advantaged options. Every investor is different, but many experts suggest you prioritize your 401(k) and IRA or Roth IRA over a taxable account. These accounts save you money when putting funds away for your critical retirement period.

However, you shouldn’t neglect taxable accounts. If you want to retire early or invest for shorter-term goals than retirement you’ve found a good reason to funnel a portion of your income into a taxable account.

>>Related: What is Tax Loss Harvesting – Capitalize on Your Investment Losses

Are There Ways To Save Taxes On Your Taxable Account?

As mentioned above, tax rates on a taxable account are based on the holding period and your total net capital gains. That gives you two methods to lower your taxes.

If you have an investment with a capital gain, holding it beyond the 12-month mark makes it a long-term capital gain for tax purposes. Compared to paying your regular income tax rate, which could easily be 10% more, keeping investments until they meet the long-term threshold can lead to significant savings.

When filing your taxes, you can subtract capital losses from capital gains. While it’s better to make money and pay taxes, if you have losses, take advantage of them to lower your taxes. If you had bad luck in the markets, capital losses exceeding capital gains are carried over to future years.

Final Thoughts: Does A Taxable Account Make Sense For You?

Nearly all investors benefit from having a taxable investment account and tax-advantaged accounts. However, if you haven’t taken full advantage of the tax-advantaged accounts available to you I recommend you start there. If you are maxing out your employer retirement account and an IRA then a taxable account makes sense.

Also, if you are saving up for mid-term goals, 5-10 years, and will need the funds before retirement then a taxable account could make a lot of sense.

If you’re looking to open a taxable account, here are the best online brokerage accounts today.

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