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Understanding Taxable Accounts vs. IRA

December 23, 2018 · 4 minute read

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Understanding Taxable Accounts vs. IRA

As pensions continue to go the way of financial folklore, tax-sheltered accounts like the IRA and 401k have been lauded as the go-to replacements for retirement planning. And the love is well deserved—they’re two solid ways to build up savings for your future.

But even though tax-sheltered accounts get all the headlines, they’re not perfect, and they’re not your only investment options. Another way to grow your wealth for either the short or long term is to invest in taxable accounts, such as stocks and mutual funds.

The most notable difference between a 401k or IRA and a taxable account is when Uncle Sam comes knocking. With taxable accounts, you pay taxes every year.

However, tax-sheltered accounts only involve paying taxes once — when you make your contribution, or when you withdraw your money. It’s a significant difference, and when combined with a number of other pros and cons on both sides of the investment coin, it’s wise to weigh all your options—not just the trendy ones.

IRA vs. Taxable Account

What are taxable accounts? Think of them as “traditional” investments accounts, like brokerage-offered investment accounts with stocks, bonds, and mutual funds sometimes managed with the help of a financial advisor. You pay taxes each year based on investment income, and your tax liability can vary based on the type of account, your activity, and your tax bracket.

One of the best reasons to consider taxable accounts is the flexibility and control of the details that you can’t get with a tax-sheltered account. When you set up an IRA, for example, your contributions can be capped and penalized up to 10% if you start withdrawing funds too early (or too late).

But with a taxable account, you can withdraw your money at any time, for any reason, without penalty. Take note, though, that penalty-free doesn’t equal tax-free. You’ll still have to pay capital gains taxes, but one upside is that the rate can often be lower than regular income-tax rates, especially if you’ve held the investment for longer than a year.

In addition, where and how much you invest with taxable accounts is entirely up to you. With an IRA or 401(k) you can often choose basic guardrails, such as your risk level, but the actual funds are managed by a third party. With taxable accounts, you can have more control. And that’s really the key to success with taxable accounts—staying on top of your investments and making changes when necessary.

For some people, this level of hands-on investing is more of a con than a pro, especially for those who are new to investing, strapped for time, or not completely comfortable with money management. It’s for this reason that individual taxable accounts are often managed by professionals. It’s their full-time job to help you create a smart, hard-working portfolio.

Gimme (Tax) Shelter

Tax-sheltered, or tax-deferred, investment accounts flip the pros and cons of taxable accounts, and all the restrictions on contributions, withdrawals, and management make them truly designed for long-term investing. Besides having money invested for retirement, the most notable advantages are a more “set it and forget it” investment style, no yearly tax burden and, in some cases, tax-deductible contributions.

The most common tax-sheltered accounts are the IRA, the 401k, and the 529(b) college savings account. Many employers offer 401k plans to employees, some even matching contributions up to a certain percent.

The 401k is one of the easiest ways to grow a retirement nest egg because the contributions are automatic and come out of your paycheck, so you may not even notice the money is gone.

The IRA is a bit more complicated because, like taxable accounts, you’ll need to manage it either on your own or with the help of a financial planner. The traditional IRA is tax-free during investment years and contributions are tax-deductible, but you’ll be required to start making withdrawals around age 70 ½ that are taxed as income.

The Roth IRA is a bit different in that contributions aren’t tax-deductible, but you aren’t subject to taxes when you withdraw.Learn more about the differences between Traditional and Roth IRAs.

Check out SoFi’s Investing 101 Center
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Which Type of Account Is Best for Me?

The old cliche, “don’t put all your eggs in one basket,” is a solid philosophy for financial planning. Investing all your money in the stock market might create amazing returns for a while, for example, but your investments can also lose significant value if the market crashes. On the other hand, relying solely on your 401k is low-maintenance, but contribution limits could put you short of your retirement goals.

Investing in a number of different “baskets” is one way to make sure that your money is working hard for you. For example, you could contribute as much to your 401k as your plan will allow, and cover any retirement-income shortages with an IRA. (Our IRA Calculator can help you determine how much you’ll need to contribute.)

Then, for the shorter term, an efficient mix of taxable accounts could ensure that you have access to your money at any time should the need arise.

Consider a SoFi Invest account today and let our invest team help you develop a smart portfolio. You won’t pay SoFi management fees, and you’ll also have access to a community of savings-minded people just like you.


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