Taxable accounts and why they matter more than people think

Ordinary brokerage accounts are frequently treated as an afterthought once tax-advantaged options are exhausted. Several of their features are genuinely useful.

The advantages

No access restrictions. Money can be withdrawn at any age without penalty, which makes taxable accounts the natural bridge for anyone retiring before retirement account access ages.

Preferential rates on long-term gains. Assets held more than a year are taxed at capital gains rates, which are lower than ordinary income rates and include a zero per cent bracket at lower income levels.

By contrast, all withdrawals from traditional retirement accounts are taxed as ordinary income regardless of how the growth occurred.

Loss harvesting. Losses can be realised to offset gains, with a limited amount deductible against ordinary income and the remainder carried forward.

This is not available in tax-advantaged accounts at all.

Step-up in basis at death. Under current rules, assets passing to heirs generally receive a basis adjustment to market value, eliminating tax on the unrealised gain.

This makes highly appreciated taxable assets among the most efficient things to leave to heirs, and argues against depleting them entirely if inheritance is a goal.

No contribution limits and no required distributions.

The disadvantages

Annual tax drag. Dividends and realised gains are taxed each year, which reduces compounding relative to a sheltered account.

Fund distributions. Mutual funds can distribute capital gains even in years when the fund fell in value, producing a tax liability with no corresponding gain to the holder.

This is one reason exchange-traded funds have become popular for taxable accounts, since their structure generally produces fewer such distributions.

Record-keeping. Cost basis must be tracked, and while brokers now report it in most cases, older holdings and transferred assets frequently have gaps.

Asset location

The practice of deciding which investments to hold in which type of account.

The general principle is to hold tax-inefficient assets in tax-advantaged accounts and tax-efficient ones in taxable accounts.

Broadly, that suggests bonds and assets generating ordinary income in tax-deferred accounts, and broad equity index funds — which generate mostly qualified dividends and little realised gain — in taxable accounts.

Assets with the highest expected growth are frequently placed in Roth accounts, since that growth is never taxed.

The benefit of getting this right is real and it is modest relative to the benefit of saving more and paying less in fees, so it is worth doing and not worth agonising over.

Loss harvesting in practice

The mechanics matter.

Selling a holding at a loss and immediately buying a substantially identical security triggers a wash sale rule that disallows the loss.

The rule applies across accounts, including retirement accounts, which catches people who sell in one account and buy in another.

The standard approach is to replace the sold holding with a similar but not identical fund — a different index tracking a comparable market — maintaining exposure while realising the loss.

Harvested losses offset gains and, unused, carry forward indefinitely, which builds a reserve that can be used against future gains.

Gain harvesting

The less familiar counterpart, useful in low-income years.

Where taxable income is low enough that long-term gains fall into the zero per cent bracket, realising gains and immediately repurchasing resets the cost basis higher at no tax cost.

There is no wash sale rule for gains, so the repurchase can be immediate.

This is particularly valuable in the early retirement years and competes with Roth conversions for the same low-income space.

Basis records

Unglamorous and occasionally worth a great deal.

For assets purchased long ago, inherited, or transferred between institutions, basis records may be incomplete.

Without documentation, the tax authority may treat the basis as zero, taxing the entire proceeds.

Assembling records while they are still obtainable — old statements, purchase confirmations, records of reinvested dividends — is worth doing before it becomes impossible.

General information only, not financial or tax advice. Tax rules change — consult a qualified tax professional about your own situation.