Your retirement is likely the largest financial goal you will ever have in your life. Because it's such a large and important goal, there are tons of specialized accounts set up specifically to help you save for it. The alphanumeric soup of such account types includes things like the individual retirement account (IRA), the Keogh plan, the simplified employee pension (SEP), the thrift savings plan (TSP), the 401(k), the 403(b), and the 457. Each of them has its own contribution rules, limits, and restrictions, creating a complicated mess of what should be a straightforward process. It's enough to make anyone's head spin.
Fortunately, investing for retirement doesn't have to be complicated. In fact, there is one retirement account I would recommend to anyone. It's one that often gets overlooked when it comes to retirement planning, but it has many unbeatable advantages for those who know how to make it work for themselves. That account is a typical, standard, ordinary, and non-tax-advantaged brokerage account.
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Incredible flexibility
Although there are tax advantages of using qualified retirement accounts, those advantages usually come with strings attached. For instance, when it comes to funding them, they tend to limit how much you can contribute, when you can contribute that money, and from what source of cash you can contribute that money. Break any of those rules, and you may face extra taxes or penalties.
Similarly, when it comes to withdrawing from those qualified plans, there are restrictions. For example, you typically have to reach age 59 1/2 (or in some cases, 55) and potentially had your account "seasoned" for long enough before you get the full benefits of those accounts. As if that weren't enough, most tax-advantaged plans are subject to required minimum distributions, which make you take money from your account (and pay taxes on it), even if you don't immediately need the cash.
Plus, in most qualified retirement plans, tapping money early can lead to a substantial penalty on top of ordinary income tax rates on money too early.
In a standard brokerage account, there are no such income restrictions, contribution limit restrictions, or age limits when it comes to contributing money. In addition, you don't need to wait until a certain age to tap your money from your standard brokerage account. Plus, should you end up never needing the money in a standard brokerage account, it can sit there throughout your entire life without needing to be tapped and taxed.
Potentially surprising tax advantages
Although standard brokerage accounts are rarely thought of as tax advantaged, they do have a few benefits. For instance, once you've held an investment in a standard brokerage account for more than one year, it becomes eligible for long-term capital gains treatment -- which often comes at a lower tax rate. Contrast that with traditional qualified retirement plans where qualifying withdrawals in retirement are generally taxed as ordinary income.
In addition, should an investment not work out, in a standard brokerage account, there's a tax benefit there, too. You can deduct a capital loss that helps offset your capital gains, and potentially as much as $3,000 of ordinary income, too. Contrast that with a qualified retirement account where it's rare to be able to deduct any losses unless your entire investing strategy winds up failing.
Plus, should you decide not to sell your investments in a standard brokerage account, they can potentially continue to grow for the rest of your life with no tax consequences. Indeed, from a really long-term perspective, under current law, investments in your standard brokerage account can get a step up in cost basis to current market value once you pass away. That can be a tremendous tax break to your heirs, in addition to the tax benefits to you.
What are the downsides?
Of course, as with any investing account, there are downsides as well as upsides associated with investing in a standard brokerage account. For one, college financial aid formulas tend to view ordinary investment accounts, but not money in qualified retirement plans, as available to pay for college costs. For another, employer-sponsored retirement plans often come with matches only if you contribute to that plan -- not to an ordinary investment account.
In addition, money in a standard brokerage account tends to be a more attractive target for lawsuits and for claims from things like expensive medical care than money in many qualified retirement plans. Those risks often mean you'll need to carry insurance to protect the money you've socked away.
On top of that, the restrictions on early withdrawals from qualified retirement accounts make it tougher to tap the money early. As a result, it's easier to resist the temptation to spend the money early from a qualified retirement account than it is to keep letting your money grow in a standard account.
Let's not forget, too, that dividends and realized gains are immediately taxable in a standard brokerage account. In contrast, any such taxes that may be owed are generally only due upon withdrawal from a qualified retirement account. That can make for a costly tax year should an investment you own in a standard brokerage account be bought out from under you or otherwise look like it's no longer worth owning.
On balance, it's worth it
Still, when you compare the downsides of an ordinary brokerage account with the improved flexibility and the reasonable tax treatment available if you manage your investments carefully, it's still worth it. That's especially true if your income comes from non-traditional sources, your employer either doesn't have a plan or it is high-cost, or if you're starting late and need to save more than qualified plans allow.
When you put it all together, a standard brokerage account really can be the one account available to anyone that can be used to prepare for and fund retirement. Treat your money in it well, and it can certainly become a key part in your retirement plan.
The key thing to remember about any retirement-related savings, though, is that time is your most important tool when it comes to building your nest egg. The sooner you get started, the more of it you have at your disposal, and the better your chances are of building a sufficient nest egg by the time you need it in retirement. So get started now, and give yourself as much time as you can to build a nest egg that just might get you through retirement.
