The premise seems savvy enough. Even if they don't eliminate taxes, contributing to a tax-deferring individual retirement account at least lets you enjoy tax-free growth of this money.
This doesn't necessarily mean every investor should only save for retirement in an individual retirement account like a 401(k) or ordinary IRA though. While they clearly have their strategic upsides, plenty of people would be well served by also by tucking away at least some of their retirement savings in a regular, taxable brokerage account.
Here's why.
Downsides of only saving for retirement in an IRA
Don't misunderstand. The ability to reduce your taxable income right now as well as grow your nest egg without worrying about paying taxes along the way is a pretty big deal.
IRAs can and do have some arguable downsides though.
One of them is required minimum distributions, or RMDs. Brokerage accounts don't impose these pesky, taxable distributions once you turn 73. As such, you're not forced to take a sizable lump sum from these accounts at a time you don't want to pay the taxes you'd otherwise owe on an IRA distribution.
At the other ends of the spectrum, should you need to access this money for an unexpected emergency, there's no 10% early withdrawal penalty from brokerage accounts.
Regular brokerage accounts also offer more flexibility in terms of funding them in the first place.
See, contributions to a Roth IRA can be limited by income, while the tax-deductibility of contributions to traditional IRAs can be impacted by participation in a workplace retirement plan like a 401(k). Not only can it get complicated for tax-calculation purposes, but you may not get the full benefit of contributing to an individual retirement account.
Ordinary brokerage accounts have no such restrictions or limitations.
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Then there's the other thing. That is, if your ultimate goal is to leave behind a tax-friendly inheritance for a loved one, special withdrawal rules can and do apply to your IRA's beneficiaries.
That's not the case with a brokerage account, though. The beneficiary's cost basis simply becomes the value of those assets as of the day the grantor passed away, and in most cases, no taxes are owed until those assets are sold by the inheritor.
Sure, you'll owe annual income taxes on dividends paid by holdings in brokerage account, as well as any capital gains taxes on positions sold in any given calendar year. That can be a bummer. But you're at least stepping up the cost basis of your portfolio as you do.
In this vein, while nobody enjoys locking in investment losses, at least losses suffered in a brokerage account can offset taxable capital gains. Losses taken inside a retirement account simply lock in a setback to its value.
At least play with the numbers
None of this is to suggest you should avoid individual retirement accounts and only utilize ordinary brokerage accounts for your retirement savings. For most people, tax-deferring IRAs will still rightly be their primary growth vehicle for their retirement nest egg.
But strategic use of a brokerage account can offer more flexibility in retirement without crimping your bottom lines. You'll just want to do a little number-crunching to see which combination makes the most sense for you.
