The Motley Fool Answers team fields plenty of questions from its listeners, and more than a few of them focus on retirement accounts. The assumption underlying most of them is that they are the best foundation for a portfolio.

But in the "What's Up, Bro" segment from this Motley Fool Answers episode, Robert Brokamp and Alison Southwick share some data to support that assumption, courtesy of Aaron Brask, who has a doctorate in mathematical finance, an investment advisory firm, and an article on AlphaArchitect.com that quantifies those benefits.

A full transcript follows the video.

This video was recorded on May 15, 2018.

Alison Southwick: So, Bro, what's up?

Robert Brokamp: Well, Alison, if you listen to our show [and I know you do]...

Southwick: I'm forced to...

Brokamp: ... you'll notice that we get a lot of questions from listeners about retirement accounts: things like IRAs, 401(k)s, and so on. Understandably, investors want to make the most of these accounts as they offer all kinds of tax breaks. But is it possible to actually quantify the value of a retirement account?

Southwick: Yes.

Brokamp: Well, I found someone who agrees with you. His name is Aaron Brask. He gave it a try, recently, in an article published on AlphaArchitect.com. Brask, who has a PhD in mathematical finance and runs his own investment advisory firm, started his study by breaking up the two tax breaks basically that are offered by retirement accounts.

The first is on the contribution to a traditional account you get a tax break and you don't report that income on your tax return. He actually doesn't spend much time on this in the article because the benefit really does depend on your tax bracket today vs. your tax bracket in retirement. This actually can be a wash tax-wise or even a detriment if you're going to be in a higher tax bracket in retirement.

The second tax benefit offered by a retirement account is that the capital gains, interest, and dividends generated by your investments in any given year are not taxed, and that leaves more of your money to grow over the decades. This, according to Brask, is really where retirement accounts provide the biggest bang.

To quantify it, Brask ran historical simulations using the rolling 20-year returns between 1968 and 2018, and he looked at various asset allocations, investment strategies, and tax brackets. The results were the value of investing in a retirement account is like earning an extra 0.7% to 2.7% each year with the average being 1.7%.

Now, the folks who benefited the most from retirement accounts are, first of all, those in a higher tax bracket. Obviously, it makes sense. Also, those who had higher allocations to bonds, because the interest from a bond is taxed as ordinary income. That's the highest tax rate. You don't get that favorable rate you would get on a long-term capital gain or a qualified dividend. You have to pay that each and every year, so those who have higher allocations to bonds actually benefit slightly more from being in a retirement account.

And also, those who did more trading, either through annual rebalancing or filing the typical asset allocation [what they call a "glide path"]. In other words, as you get closer to your retirement, you become more conservative, sell some of your stocks to buy bonds, but then when you sell those stocks you have to pay capital gains unless it's a retirement account, so the more you are doing that traditional glide path, the better off you'll be in a retirement account.

Now, earning just an extra 1.7% a year may not sound like much, but let's look at some numbers. Let's say you have a $100,000 portfolio. It's in an IRA. Earns 8% a year. After 20 years, you'd have $466,000. However, if it were outside of a retirement account, and you earned 1.7% less because of those taxes, you would have just $339,000 [in other words, a difference of $127,000], which is more than the $100,00 you started with.

Obviously, the key takeaways, according to Brask, is using an IRA or 401(k) to save retirement is an easy way to boost your after-tax returns and it makes sense, generally, to leave the money in there as long as possible, so when you retire, you should generally tap your non-retirement accounts, first, and leave that money in those retirement accounts to grow through the years.

And I'll add a couple of other conclusions that are implied by this article. First of all, if you think you'll be in a higher tax bracket in retirement, you're better off choosing the Roth over a traditional retirement account. He didn't talk about that in the article, but that's an important consideration, especially these days where tax rates are pretty low. And for money outside of retirement accounts, choose tax-efficient investments like non-dividend-paying stocks or tax-efficient funds that you'll hold for many years.

Southwick: You sound like that's it, but sometimes all this advice is so hard. There's so much advice out there, it's hard to be like, "Oh, wait. Now I'm not supposed to own dividends." It's hard to know how much you let this influence your portfolio.

Brokamp: Let's say there's a stock that you like and it pays a solid dividend. If you have a choice between putting it in an IRA or in a regular brokerage account, put it in the IRA, at least while you're saving for retirement. If you're going to choose to have some bonds or something that pays a good deal of interest, generally speaking it's better to have it in your IRA.

But you should definitely not make investment decisions based solely on taxes. If you find a good stock that's paying a good dividend, and you don't have, for some reason, room in your 401(k) or your IRA, go ahead and buy it outside. It's better to still have the good investment rather than just to avoid paying some taxes.

Southwick: Thanks!

Brokamp: You're welcome!

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