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The Benefits of Taxable Retirement Savings

Read below for 6 benefits to having taxable brokerage assets in retirement.

By Amy Shepard, CFP, RMA

There are essentially three different tax buckets that can be utilized for retirement savings - pre-tax (also known as traditional or tax-deferred), Roth (tax-free), and taxable (brokerage).

Amy Shepard, CFP®, RMA®, BFA®, MBA, is a partner and financial planner with Sensible Money. She has a passion for financial planning and loves working with clients to help them gain the financial confidence to live the life they envision. Amy has a Bachelor's in Accounting and an MBA. She is a CERTIFIED FINANCIAL PLANNER™ professional, a Retirement Management Advisor®, and a Behavioral Financial Advisor™.

Amy Shepard

Most people are well aware of the benefits of saving for retirement in pre-tax retirement accounts, such as a 401(k); they receive a tax deduction now but have to pay ordinary income tax on any withdrawals later on. Fewer people, although increasing steadily, are familiar with the benefits of Roth savings; pay tax now but withdrawals (including earnings) are tax-free later on. The third bucket, taxable brokerage savings, is often an underutilized yet powerful tool for retirement planning. Some of the major benefits of having taxable brokerage assets in retirement (in no particular order) are:

1. Potential to manage Modified Adjusted Gross Income (MAGI) to qualify for healthcare premium tax credits (via during the period after retirement but before Medicare. At Sensible Money, we've helped several retiree clients use this strategy to pay ZERO (or very low) health insurance premiums, even though their total investment assets were well over $1M and their annual spending was close to $100,000. The key is to avoid IRA withdrawals that are often 100% taxable and limit the need to realize capital gains. Using a bond ladder approach is ideal in this scenario because only the interest income impacts MAGI; the bond maturity proceeds are simply a return of principal and don't impact your tax return.

2. Potential to manage MAGI to pay lower Medicare premiums throughout retirement. Medicare is means-tested, which means premiums are determined based on your tax return two years prior. For those with MAGI above a certain threshold ($91,000 for single filers and $182,000 for married filers in 2022), you are subject to an Income Related Monthly Adjustment Amount (IRMAA) for your Part B premiums. With taxable brokerage assets, you can follow the strategy outlined above to manage your MAGI more carefully with regard to IRMAA, which could save considerable amounts of money on Medicare premiums over your lifetime.

3. Having liquid assets available to pay taxes on Roth conversions. Yes, you can pay these taxes directly from the IRA where you're converting from, but you get much more bang for your buck when you pay the taxes from non-retirement assets such as taxable accounts like brokerage or bank accounts.

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4. Potential tax savings for heirs. With current rules, IRAs (traditional and Roth) inherited in 2020 or beyond require the beneficiary to deplete the account within 10 years. With a traditional IRA, distributions are typically 100% taxable, so depending on the account value, that could result in quite a bit of tax liability over that 10-year period. With taxable brokerage accounts, there are no distribution requirements and there is also something called a "stepped-up basis" that the heir receives, which has the potential to drastically impact any future tax liability.

5. Greater flexibility to fund an early retirement. With taxable assets, there are no age restrictions or 5-year rules to worry about as there are with pre-tax or Roth accounts. For those who may want to retire before age 59.5 or even before age 55, taxable assets provide an opportunity to fund an early retirement without having to tap retirement accounts and incur a 10% early withdrawal penalty.

6. Longer time horizon for Roth assets to grow tax-free. You might have read the first 5 points and thought "I can do most of those things with my Roth assets," and yes, that's true. However, the added benefit of having taxable assets is that you can now leave your Roth assets alone for a longer period of time, giving you the opportunity to capitalize on more potential tax-free growth over the long run.

About the author: Amy Shepard

Amy Shepard, CFP®, RMA®, BFA™, MBA is a financial planner at Sensible Money. She has been working with clients since 2013 and loves helping them create and implement a financial plan so they can achieve their life goals. She is involved in the CFP Boards Mentor Program and previously served on the board of the FPA of Greater Phoenix. Outside of work she enjoys spending time with her husband and kids – they have a goal to take a family picture in all 50 states!

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