If you are in a high tax bracket and focused on long-term financial goals, it is wise to maximize contributions to tax-advantaged accounts before investing in taxable accounts.
If the gap between your capital gains tax rates and your normal income tax rates shrinks (e.g., because your income changes or tax rates change), then tax-advantaged accounts will be better. If the gap widens, then a taxable account is better.
Once you have reached the contribution limits of tax-advantaged options, consider using taxable accounts. Adopt a holistic approach that matches your financial goals and time horizon when investing in these accounts.
Very useful article on Bogleheads — “Tax-efficient fund placement”
A major advantage of taxable brokerage accounts is the flexibility they offer in terms of ownership. You have the option to set them up as joint accounts, which is a vital aspect of estate planning. This structure ensures that your family members can access the funds after your death without undergoing probate, offering financial security and administrative simplicity.
Capital gains are not taxed until the stocks are sold, allowing you to defer taxes. When stocks are sold, the gains are typically taxed at the lower long-term capital gains rate. Dividends that qualify are taxed annually but at a lower rate than ordinary income.
You can sell stocks at a loss to offset gains, which can reduce your taxable income.
Donating appreciated stocks to charity can avoid capital gains taxes.
Stocks held until death may receive a stepped-up basis, potentially reducing capital gains taxes for heirs.
Consider holding $10,000 in a stock index fund for 30 years, with an 8% pre-tax return (2% from dividends taxed at 15% and 6% from price increases). Annually, you pay 0.30% tax on dividends and reinvest the remainder. After 30 years, the investment grows to $92,570, with a basis of $28,230 including reinvested dividends. Selling the stocks then incurs $9,651 in taxes on the $64,340 capital gain, resulting in a final value of $82,919 and an annual return of 7.30%. Effective tax management strategies like loss harvesting or charitable donations could further increase returns.
Bonds generally have lower returns than stocks, potentially leading to a lower overall tax burden.
Nominal Treasury Bonds and TIPS are exempt from state income taxes. In-State Municipal Bonds are not subject to state income tax and often offer lower effective tax rates compared to other income sources.
Interest from municipal bonds does not increase AGI, which is beneficial for qualifying for various tax deductions and credits, unlike dividends and capital gains which do increase AGI.
Holding bonds in a taxable account allows easier rebalancing without significant capital gains tax implications, unlike stocks which may have large unrealized gains.