The benefits of tax-deferred accounts like 401(k)’s, IRA’s, and HSA’s, among others, are often touted and generally for good reason. That said, the benefits of a taxable investment account tend to be overlooked but can be meaningful as well. This post will go over financial planning benefits a taxable investment account can provide as part of a tax diversified portfolio.
Tax Planning Opportunities
When assets are sold in a taxable brokerage account, they are subject to capital gains taxes. This tax is based on the gain of the investment and is subject to your income tax rate if the investment is sold less than a year after purchasing but more favorable long term capital gains rate if held for more than a year. These rates can range from as low as 0% up to 20% and are shown below:
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
| Single | Up to $47,025 | $47,026-$518,900 | Over $518,900 |
| Head of Household | Up to $63,000 | $63,001-$551,350 | Over $551,350 |
| Married Filing Jointly | Up to $94,050 | $94,051-$583,750 | Over $583,750 |
| Married Filing Separately | Up to $47,025 | $47,026-$291,850 | Over $291,850 |
| Estates and Trusts | Up to $3,150 | $3,151-$15,450 | Over $15,450 |
Additionally, if your income is over $200,000 if single or $250,000 if married filing jointly you can be subject to an additional 3.8% Medicare surtax bringing the top total tax rate to 23.8% of the gain.
For those with income below a certain threshold, a 0% capital gains tax rate can be achieved meaning no tax would be due on the sale of long-term assets up to the threshold.
Example: Bob, recently retired, has yet to draw Social Security and will sell assets from his taxable investment account to cover lifestyle expenses. He has no income other than the interest and dividends produced by his portfolio. In order to cover his annual expenses, he realizes $20,000 in long term capital gains but is able to stay under the $47,025 threshold for the 0% capital gains tax bracket for single filers meaning he will not owe any taxes on his capital gains.
When an investment has gone up significantly, the tax bill associated with selling the asset can be large. A charitably inclined individual can gift shares of the appreciated stock to avoid having to pay capital gains taxes on the growth of the investment. The charity is then able to sell the investment with no tax due.
This strategy allows someone to achieve an itemized tax deduction in the value of the stock on the day it is granted and avoid the capital gains taxes they would have owed had they sold the stock themselves.
Example: Bob owns ABC Co. stock that he purchased for $1,000 and is now worth $40,000. He elects to donate the stock to his favorite charity who then can sell the shares tax free. Bob will receive a $40,000 itemized tax deduction for the gift and avoid having to pay long-term capital gains taxes on the $39,000 worth of growth.
The capital gains tax an individual owes is not based on the gain of each investment but the netting of all gains an individual realizes each year offset by any losses that they realized. Long-term gains are netted against long-term losses while short term gains are netted against short term losses.
When an investment declines in value, it can be sold to realize a loss that will be used to offset gains. To maintain the loss, the security sold or one that is substantially equal cannot be purchased within the 30 days prior to or after sale of the security.
These losses are netted and if there is a total net loss you are able to use $3,000 to reduce your taxable income for the year. Any additional losses are then rolled over to be used to offset the next years gains.
Accessibility of Funds
Pre-tax retirement accounts are subject to income taxes on the full distribution amount when funds are needed. If you are under the age of 59.5 and an exception does not apply there is a 10% early withdrawal penalty that is applied to the distribution amount as well.
Even with Roth IRA’s, withdrawals before 59.5 can be subject to income taxes and penalties if the amount withdrawn is greater than your contributions into the Roth accounts.
Taxable brokerage accounts allow for access to funds at any age and for any reason. This can provide you with great flexibility to pursue goals prior to 59.5. This could be buying a new or second home, starting a business, or retiring early to provide some examples.
As we discussed earlier, the tax is incurred on the sale of investments not the withdrawal of funds. Additionally, the tax is only on the growth of an investment leaving the principal tax free. This means that if structured properly, capital can be accessed with little to no taxes due depending on the growth of the investments in the portfolio.
Example: Bob has a $1 million taxable portfolio and needs to take a withdrawal of $200,000 to use towards a new home. He holds ABC fund with a basis of $75,000 and a value of $100,000 and XYZ fund with a basis of $110,000 and a value of $100,000. Both funds are long term and he sells them to generate the $200,000 cash he needs. He is able to net the $25,000 gain of ABC fund against the $10,000 loss of XYZ fund for a net $15,000 long term capital gain. If Bob falls into the 15% long term capital gain bracket he will owe $2,250 in taxes to access the $200,000.
Ability to Take Securities-Based Loan
For those with significantly appreciated investments it may be more difficult to sell securities as there is less opportunity to cherry pick losses. In this case, a securities-based line of credit could be used to access capital without realizing a gain on the investment.
This option has become less attractive as rates have risen. An account holder with large gains can take a loan against their portfolio, pledging the securities in the portfolio as collateral. The securities don’t have to be sold, the loan will accumulate interest, and as long as the loan stays within a required and manageable range compared to the value of the portfolio does not have to be paid back with specified payments.
This is often a solution to consider when bridging a gap where money is needed just for a set period of time. An example of this would be purchasing a new home before an existing home has been sold. The securities based loan would act as a bridge to purchase the new home until the existing home was sold and the proceeds used to pay off the securities loan.
Example: Bob has a $1 million portfolio and is purchasing a new home and needs $200,000 for the down payment. His existing home has not sold and he does not want to miss out on the purchase of the new home so he takes a $200,000 securities based loan from his portfolio to use for the down payment. A few months later, he sells his existing home and uses the proceeds from the home to pay off his $200,000 loan and the interest that has accumulated since the loan was taken.
Estate Planning Flexibility
At the passing of an account owner, taxable investment accounts receive a step up in basis. For individually owned accounts and joint accounts owned by spouses residing in a community property state that step up is equivalent to the value of the security on the date of death of the account owner, completely eliminating the gain in the security.
For significantly appreciated assets, the decision to hold that asset until one of the spouses passes away could provide a significant tax savings for those in a community property state. In the interim, a securities-based loan could be used to access the value of the holding before that time.
Example: Bob and Sue have a $1 million taxable investment account holding ABC co. stock with a basis of $1,000. Due to the tax impact of selling, they choose not to sell the shares and instead take a securities-based loan as needed to access the value of the stock. Bob passes away and being in a community property state Sue is able to step up the basis on the ABC stock to the $1 million value on the date of Bob’s passing. They had taken out $100,000 against their securities-based loan and Sue is able to sell all $1 million of ABC stock for no tax consequence, pay off the loan, and reinvest the remaining $900,000 in a diversified portfolio.
Additionally, a taxable investment account gives an account owner abilities to tax efficiently gift assets out of an estate during their lifetime. In 2024, the gift tax exclusion is $18,000 per person, per recipient.
That amount can be given as cash by selling securities that are down for a tax loss and gifting the cash. It can also be given through investments, by gifting appreciated stock that the recipient can continue to own or sell at their capital gains tax rate.
Disclosure: 401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice.
