Given the choice between something that is “taxable” or “nontaxable,” most people would choose nontaxable. But when it comes to investment accounts, multiple factors affect which type of account might best help you meet your savings and investment strategies. Many investors use a combination of taxable and nontaxable accounts to meet short-term investment goals and to help control the amount of taxable income they will have each year in retirement.
A nontaxable account is typically a pre-tax retirement account, such as a traditional IRA. A traditional IRA owner receives a tax deduction in the year dollars are contributed to the IRA. Taxation on the contributions and any investment growth is delayed until money is taken out of the IRA. Both the amount of the original contribution and investment earnings will be taxable as ordinary income when the assets are withdrawn from the IRA. (A Roth IRA follows different tax rules.) Because of the tax benefits associated with IRAs, tax laws set contribution limits and eligibility requirements to limit the amount of tax deferral.
A taxable account allows an investor to deposit funds and buy and sell investments. It is not a tax-qualified retirement account. There is no tax incentive available at the time funds are deposited, but the purchase price creates a basis that will not be taxed when the asset is distributed or sold. Some taxable accounts generate annual taxable income (e.g., interest on certificates of deposit, mutual fund dividends). For certain investments such as stocks, bonds, and other property, the increase in value above the initial purchase price will be taxable in the year the asset is sold and may qualify for lower capital gains tax rates if the asset has been held for more than one year. There are no tax law restrictions on contributions or eligibility.
Investors often choose to use both taxable and nontaxable accounts to meet their short-term and long-term saving and investment goals. Nontaxable accounts provide tax incentives up front, while taxable accounts allow an individual to save and invest funds above the contribution limits on IRAs and other retirement plans. Because investors are not forced to deplete a portion of their taxable accounts each year in retirement as RMDs, taxable accounts can be used to grow assets for heirs.
Mainstar Trust offers both taxable and nontaxable accounts with the option to explore alternative investments along with more traditional assets including stocks, bonds and mutual funds.