By the time you retire, you may have spent thirty or forty years arranging your financial life around getting money into retirement accounts. You increased contributions when you got a raise, weighed traditional versus Roth contributions, and watched your balances grow. A brokerage account, if you had one, was where you invested whatever was left after taking advantage of the accounts with better tax treatment.
Once you begin spending those savings, the brokerage account deserves another look. Perhaps you want to replace the roof in a year when your required minimum distribution has already supplied more taxable income than you wanted. Or you have an opportunity to convert part of an IRA to a Roth, provided you can cover your living expenses and the conversion tax without another large IRA withdrawal. Taxable savings may help you meet those needs while limiting the additional ordinary income on your return.
A taxable account comes with ongoing tax costs, but judging it only by those costs misses much of what it can do for the rest of your savings.
What Actually Gets Taxed?
The term “taxable brokerage account” can make it sound as though every dollar you withdraw will be taxed. When you sell an investment, however, the gain or loss is measured against its adjusted cost basis, which usually begins with what you paid.
Suppose you sell shares for $30,000 with a $24,000 basis. You have generated $30,000 of cash, but the sale produces a $6,000 capital gain. The other $24,000 represents a recovery of your investment and is not taxed again.
Compare that with withdrawing $30,000 from a traditional IRA funded entirely with deductible contributions. The entire withdrawal generally enters ordinary income. A qualified Roth withdrawal would generate no federal income tax. Each transaction supplies the same cash before taxes, with a different effect on your return.
Even if you hold your investments without selling, interest, dividends, and fund capital-gain distributions can generate an annual tax bill. When you pay those taxes from the account, less remains invested to compound over retirement. That ongoing cost deserves consideration alongside the flexibility you gain when choosing what to sell.
The Tax Cost Depends on the Rest of Your Annual Income
The tax on that $6,000 gain depends on your holding period and the rest of your income. Gains on investments held for one year or less are generally taxed at ordinary income rates. Most net gains on investments held longer than one year qualify for federal long-term capital-gains rates of 0%, 15%, or 20%. State taxes and, for some households, the net investment income tax can add to the bill.
Long-term capital gains and qualified dividends generally sit above ordinary taxable income when determining their federal tax rates. Some or all of the $6,000 gain might qualify for the 0% rate in a low-income year, while an IRA withdrawal or Roth conversion could use up that room and push the gain into a higher rate.
Even the 0% rate does not mean the gain has no consequences elsewhere. Recognizing it may make more of your Social Security benefits taxable or increase future Medicare premiums, which generally use income from two years earlier. Before selling, project the year’s income, including required distributions, conversions, interest, and dividends. Evaluating the sale alone can miss much of its cost. A tax map can lay that projection out on one page and show where each additional dollar of income starts to cost more, and our workshop on Using Tax Maps to Enhance Tax Planning Decisions for Retirement walks through how to build one with your own numbers.
Choosing Which Shares to Sell
Purchases of the same investment at different prices create separate tax lots, and choosing among them can change how much gain you recognize.
To cover the $30,000 roof expense, you might sell one group of shares with only $2,000 of embedded gains, while selling another group would generate $18,000 of gains for the same proceeds. When properly used, specific-share identification allows you to tell the brokerage firm which shares to sell. Check the account’s cost-basis method before placing the trade since the default may not produce the result you intended.
Review the holding period along with the basis, since a smaller gain taxed at ordinary income rates will not always cost less than a larger gain qualifying for long-term treatment. Selling high-basis shares preserves more of the portfolio’s existing unrealized gains for a future sale. If you expect to spend those investments later, consider whether a lower-income year or losses elsewhere in the portfolio could provide a less costly opportunity to sell.
Funding the Years Before Age 59½
Taxable savings can fund early retirement without requiring an exception to retirement-account early-distribution rules. Brokerage withdrawals have no retirement-age requirement, while taxable traditional IRA withdrawals before age 59½ generally face an additional 10% tax unless an exception applies.
That access is most useful when the investments fit your planned spending timeline. Money needed for the next year’s expenses may belong in cash or short-term holdings, even if the brokerage account also contains stocks intended for much later spending. If those expenses cannot be postponed, relying on stock sales could leave you selling during a market decline.
Working Around Required Minimum Distributions
Required minimum distributions (RMDs) must be satisfied even when you do not need the money, and the taxable portion generally adds to that year’s income. Selling brokerage investments instead does not remove the RMD obligation.
Begin by determining how much spending the RMD covers after taxes. There may be no reason to sell additional investments simply because your original plan said to spend taxable assets first. For expenses beyond that amount, selling high-basis shares may generate less income than another pretax IRA withdrawal. A qualified Roth withdrawal could avoid additional taxable income altogether, but you may prefer to preserve some Roth savings for later needs.
If the RMD exceeds your spending, unused proceeds can be invested in a taxable account after allowing for taxes. Reinvestment does not reverse the distribution’s tax consequences, but the money can remain invested for future needs.
Paying for a Roth Conversion
Taxable savings can be especially helpful during the years after work ends but before Social Security and RMDs begin. Covering expenses with brokerage cash and sales with modest gains may leave more room to recognize ordinary income through a Roth conversion. Outside savings can also pay the conversion tax, allowing the full amount selected for conversion to reach the Roth.
Where the tax payment comes from can change the cost of the conversion. Selling appreciated brokerage holdings generates additional gains that belong in the same income projection. Taking more from a pretax IRA generally adds ordinary income, and any IRA money retained for taxes before age 59½ may also face an early-distribution penalty unless an exception applies.
A conversion still needs to justify its current tax cost and the forgone growth on money spent paying that tax. Compare those costs with the likely tax treatment of future withdrawals. In an RMD year, satisfy the applicable required distribution before converting additional IRA assets; the RMD itself is not eligible for conversion.
When Accounts Become Part of the Estate Plan
Investments intended for heirs may warrant a different approach to selling. Under current law, inherited investments in a taxable account generally receive a basis adjustment to their fair market value at the owner’s death. For appreciated holdings, this “step-up in basis” generally eliminates the unrealized capital gain accumulated through that date. Giving shares during your lifetime generally does not provide the same treatment. Ownership and estate arrangements affect the adjustment, particularly for jointly owned assets.
An inherited pretax IRA generally retains its income-tax obligation. Most adult children inheriting an IRA from an owner who died after 2019 must empty the account by December 31 of the tenth year following the year of death under rules established by the original SECURE Act. Those withdrawals may arrive during the children’s highest-earning years.
Annual required distributions generally also apply within that period if the owner died on or after the required beginning date. Exceptions are available to eligible designated beneficiaries, including surviving spouses and certain other individuals. Estates and some trusts follow different rules, making beneficiary designations important to review.
These rules can change which assets you spend. Taking IRA distributions at a modest effective tax rate during your lifetime may preserve appreciated taxable holdings for heirs who would otherwise inherit IRA income at higher rates. The calculation may favor another approach if your tax rate is high or your beneficiaries expect lower-income years.
Qualified inherited Roth withdrawals are tax-free, even though most adult children still face a ten-year deadline to empty the account. Creating that inheritance through conversions, however, requires weighing the benefit against your own conversion taxes.
Preserving appreciated investments must also fit your spending needs and portfolio risk. A concentrated stock position can lose far more than the capital-gains tax you hoped to avoid.
What Each Account Contributes to the Retirement Plan
Households with substantial pretax and Roth savings may already have considerable flexibility. When most savings are pretax, however, a smaller Roth balance may be insufficient to cover every expense that would otherwise create an unwelcome tax bill. Taxable savings provide another source of cash, including the ability to recover basis without recognizing income.
That benefit comes with annual taxes and more investment-sale decisions. There is no need for equal balances across account types, and building brokerage savings should not automatically take priority over valuable retirement-plan benefits.
When reviewing your accounts, project the withdrawals you expect over the next several years, including RMDs and planned conversions. Then consider where you would find the money for a larger expense. If covering it would require another substantial pretax IRA withdrawal, compare that result with selling specific brokerage holdings or taking a qualified Roth withdrawal. Include the resulting taxes in the amount you would need to withdraw.
For investments you expect to leave behind, extend the comparison to your beneficiaries. Spending from an IRA at a relatively modest tax rate may preserve appreciated holdings that your children can inherit with an adjusted basis. Their likely tax circumstances, together with your spending needs and investment risk, can help determine which assets you use first. Those decisions deserve to be revisited as retirement unfolds, especially when income or family circumstances change.
Want to learn more? Listen to Episode 252 of the Retire With Style Podcast.
