Ready For Retirement
Ready For Retirement
Why Brokerage Accounts Might Be the Most Underrated Tool in Your Financial Plan
Retirement accounts like 401(k)s and IRAs often get all the attention, but there’s another tool that can play a powerful role in your long-term strategy: the humble brokerage account.
Unlike retirement accounts with age restrictions and penalties, brokerage accounts offer flexibility. You can access funds at any time, for any purpose without early withdrawal penalties. That kind of control can be incredibly valuable, especially if your goals include retiring early, helping family, or funding big life moments along the way.
Having a mix of account types—pre-tax, Roth, and brokerage—can give you more control over your income and taxes in retirement. It also helps you avoid a common challenge: having most of your wealth tied up in accounts that are difficult (or costly) to access when you need them most.
A thoughtful strategy includes more than just maxing out retirement accounts. It’s about building flexibility, tax efficiency, and confidence into every stage of your financial life.
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Advisory services are offered through Root Financial Partners, LLC, an SEC-registered investment adviser. This content is intended for informational and educational purposes only and should not be considered personalized investment, tax, or legal advice. Viewing this content does not create an advisory relationship. We do not provide tax preparation or legal services. Always consult an investment, tax or legal professional regarding your specific situation.
The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
Comments reflect the views of individual users and do not necessarily represent the views of Root Financial. They are not verified, may not be accurate, and should not be considered testimonials or endorsements
Participation in the Retirement Planning Academy or Early Retirement Academy does not create an advisory relationship with Root Financial. These programs are educational in nature and are not a substitute for personalized financial advice. Advisory services are offered only under a written agreement with Root Financial.
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Now, james, there's something called a brokerage account. It's also called a taxable account. It's also called a joint account and an individual account. There's so many different names because the financial industry just wants to keep you on your toes? No, but in all reality, we call it the superhero account because this is an account that many people are not aware of in terms of how should you be invested inside this account and also just what are the benefits of that. So this is a superhero account.
Speaker 1:I literally had someone call up Vanguard and tell me they tried to open a superhero account and that they had no idea what they were talking about because it's not a real name. We just call it the superhero account, which is, once again, a brokerage account. So today we're going to talk about what are best practices with this account. Why is it we even call it superhero account? Are there other names that will use root reserves and otherwise for what we do at root? Yes, there are. We're going to hop in. First thing I want to do is read the comment, and this was in our community, and Abe T says so. I've heard a lot about how cool this account is, et cetera, et cetera. Sure, I understand what it is and why it's says so. I've heard a lot about how cool this account is, etc. Etc. Sure, I understand what it is and why it's good, blah, blah, blah but I want to understand if there are actual cons of this superhero account. So why on earth, james, do we even call it a superhero account?
Speaker 2:Well, typically investing, kind of equals retirement. In most people's mind, I'm going to invest money because one day I'm going to stop working, and that's true. But that's a very binary thing. This money is either to be spent today or this money is to be spent in retirement. And retirement accounts are things like 401ks, IRAs, Roth IRAs, et cetera. Wonderful accounts, lots of great benefits to them, but a brokerage account.
Speaker 2:So if someone's wondering, just if it's not clear by now, if you go to the IRS website and look up, superhuman nothing's going to pop up. So let's be very clear this is not the legal, technical IRS given name. It's just a name that implies the sense of if you have this account, it gives you way more flexibility. It provides you way more optionality. You can invest your money.
Speaker 2:You could spend it on a car before retirement age a vacation. You could spend it on a car before retirement age a vacation. You could use it to retire early. There's just so much more flexibility that comes with this account that I think a lot of people don't realize. Retirement accounts are wonderful, but they do come with some handcuffs in terms of timing, of when you can use the money, or potential penalties or the long-term taxation of how some of these accounts work. The superhuman account, the brokerage account, is just a wonderful type of an account to have. That gives you tremendous optionality in terms of when you retire your withdrawal strategy, your tax strategy just a lot of cool things you can do with that to optimize your overall financial picture.
Speaker 1:We'll go through the basics of it, so everyone's aware. But I think the number one thing I hear when speaking to all of you and reading the comments is what do you mean? I shouldn't max out my 401k or max out my Roth? I've always been a maxing out guy. I want to max it out. There's a reason they put a max. I want to do as good as I possibly can. Now you're saying maybe I shouldn't possibly max this out and this other superhero thing doesn't even have a max.
Speaker 1:Why is it so many people, james, come to us that are qualified rich cash poor? So many of you know house rich cash poor. But qualified rich cash poor is when so much of your money is locked up that now you're hypothetically 53, you want to retire all your money's in a 401k. You might have four or five million bucks, but you can't retire because of the taxes and penalties, which is crush you. So this qualified rich cash poor this is a lot of you, and that is because you're maxing out year after year. Why do people make this mistake?
Speaker 2:Yeah, and and I wouldn't go so far it can be a mistake for sure, depending upon your goals. So we'll back up and look big picture. But why? It is because what I just mentioned is there's this sense of oh, you're supposed to max out your 401k, because you have it and it's attached to payroll and you get a match and the IRS tells you you can put a certain amount in. So it's kind of fun. You feel like you're gamifying the system a bit to say I'm maxing this out every single year, whatever the number is. There's almost that sense of like the same feeling you get when you check a box when you max a 401k, like you've done everything you can. You've accomplished that task.
Speaker 2:The problem comes down to saving money in a 401k isn't saving you taxes, it's deferring taxes. Now there's a difference there. Deferring taxes doesn't mean you don't pay them, it just means you pay them at a later date. So, hypothetically, if I'm in a 22% tax bracket today and I put money in my 401k and then I pull it out and I'm still at 22% tax bracket, it hasn't saved me anything. Now I have deferred taxes the interest, the growth along the way. There's not been any tax. I haven't had the tax drag on what my returns have been, but it's just kicking that can down the road. So where is that strategy best? That strategy is best when you're saving your 401k in really high income years and you're pulling out in much lower income years. So can I save? Can I put money in when I'm in a 32% tax bracket and save 32 cents on the dollar and pull it out, hypothetically, when I'm in a 12% tax bracket? That is a savings of 20%, the delta between what I saved putting it in versus what I paid pulling it out.
Speaker 2:The example you're giving Ari, which is a very good one that person who's got several million dollars saved in their IRA and they're 53 years old and they wanna retire.
Speaker 2:Well, if they have that amount in their IRA, they're probably a really high income earner their whole life. So they're saving at a high rate. But also, I'm guessing they're going to maintain some of that lifestyle in retirement. And if all their money is in their IRA, well, guess what it's coming out and you're probably going to pay at a pretty high rate as well. Not to mention, you might even have this early distribution penalty because you can't pull that money out at the age of 53, with few exceptions, without paying both taxes and a penalty. So do you have this superhuman account the name that we'll use to describe brokerage accounts to say now you have some flexibility, some optionality. You're not handcuffed to your job based upon the type of an account you save to. You have way more flexibility because you'll use the right types of accounts along the way to buy yourself freedom to use it whenever you want to use it.
Speaker 1:Love it. I had a client who was very transparent, said I know you call it superhero and you wear the silly cape and do all those things, but can you just break it down real simple. Why would I actually consider this? Because I like the idea, while I'm in a high tax bracket, to defer money to a 401k. I said, yeah, I'll give you an example. It's not perfect, but I told them why would you ever rent? They said, well, I value flexibility. I said what if it was cheaper to buy, meaning renting would cost you more. You could go buy something. They said, well, I just don't know where I'm going to live next year. I want to follow my children around. That's my main goal in retirement. I'll say so. There is a time where you might be able to buy something. You actually want more and would choose to rent. And they say, yes, not a perfect analogy, but the idea here with the superhero account is you're intentionally saying I don't want a tax deduction today In exchange for choosing how I go invest this so you can invest it safely. You can invest it very aggressively. You could choose what you want to do, just like a 401k. The difference is there's no actual rule that says you have to wait until a certain age to pull the money out. There are still taxes, there's capital gains, there's things you need to be aware of, but you are really prioritizing flexibility.
Speaker 1:A lot of people use this instead of a 529 or in addition to a 529. Or they'll actually say you know what? This brokerage account, this superhero account, this is going to be where I go save money for that future travel and the idea of having to pull more money and pay more taxes in retirement most of you listening you've already done a good job saving and investing. You might have a million or two million bucks in a pre-tax account. If you keep adding money to that, you're just adding to a larger tax burden. So the idea of maybe pausing for the first time in your life and not maxing out your 401k, maybe just getting the full match because James and I love free money, and putting the rest into a superhero account or something else, it might make a lot of sense. You may just have never considered it before.
Speaker 2:Yeah, and obviously this is where having a financial plan, a financial advisor, can add a lot of value. Just to help and understand, sometimes what is best is that 401k. That's just the reality, only 401k. A lot of times there's a case to say that's not what the best thing to do is and why I like it actually is for the reasons you're talking about, ari. There's so many financial benefits, but there's also the psychological benefit.
Speaker 2:We talk a lot about the challenges of people go 35 years, 40 years, 45 years, putting money into their portfolio and then all of a sudden, now it's time to start pulling money out of your portfolio. You're retired, it's time to start spending and that's a very difficult transition for a lot of people. They're used to seeing the dollar value grow in their account, both from market growth, hopefully, and contributions. Psychologically, flipping that switch and pulling money out is very difficult to do and it is made more difficult when you know that every single dollar you pull out is going to be taxed at ordinary income rates. Ordinary income rates are the higher rates that you pay on money that comes out of an IRA or your salary. Those are taxed the same ordinary income rates, whereas brokerage accounts they have much more tax preferred treatment.
Speaker 2:If you hold your investments for over a year, you get taxed at capital gain rates, long-term capital gains rates, which can be either 0% or 15% or 20% at the federal level. That's a lot easier to justify than rates that go from 10% to 37%, plus potential state taxes, if you're pulling out of an IRA. So not only is it the difficulty of spending, but it's a difficulty of just that sense of every dollar I pull out is going to be one extra dollar of taxable income. And how often are we to see people not do things that they very well could afford to do, that we encourage them to do, but they can't get over the spending hurdle. And then they can't get over the tax hurdle of what it's going to mean and it ends up meaning they do less than they otherwise could have, because of even the psychological side of spending in retirement.
Speaker 1:The answer is too often, and we will see people who are on track for retirement that we will tell not to retire and people you probably just heard that going well, that doesn't make any sense at all. Here's what we mean. If all of your money is in a 401k and you retire and you go, it's time I've been saving for this day. We're buying the RV. It's going to be $150,000. We've got kids in college, we're also taking trips, we have healthcare and we're doing a home remodel.
Speaker 1:The tax liability on that is going to be significant. That's ordinary income taxes, as James just explained. If you have a superhero account, you might go. You know what? What if we actually we don't need that RV. This year We've got healthcare, but next year we're going to be 65. Medicare is coming on. We're actually going to then decide we're going to take a bigger trip or we're going to start to space out some expenses. You can actually massage your income with something like a superhero account as opposed to a 401k. So, no matter the balance, it will often cause people to not do things that they're in a perfectly fine financial position to do because it just feels not so fun. Yeah, yes.
Speaker 2:So tremendous financial benefits, tremendous psychological benefits. The reality is a well-designed financial plan. You probably have some mix of pre-tax money, some Roth money and some brokerage money, or in other words, superhuman money. That's the best of everything when you have the optionality to say here's my accounts. I have some in Roth, some in IRA, some in brokerage, some in an HSA, someone in brokerage, someone in HSA. The power there is you get to create your own, not tax bracket, but your own taxable income. You can pull income to say how do I pull the right amounts from the right places? How do I design the right amount to have in dividends and interest and capital gains and IRA withdrawals and Roth withdrawals and HSA withdrawals to coordinate with social security, with pension, with other things?
Speaker 2:It can get pretty complex, but the power with that is the ability to manufacture the taxable income that is right for you, which often means how do we minimize what that tax liability is going to be over the course of your retirement, which helps actual save, real dollars. But it also helps with that psychological sense of freeing you up to go spend your money, because the only reason we save is for future consumption and what we don't like seeing is when we save, save, save, but that consumption never happens because psychologically we can't bring ourselves to do it. This is a wonderful way to say consume now and in the future. And it doesn't just have to be now and then, once you're over 59 and a half, it's at any point along the way. That brokerage account, that superhuman account, can be used for a rainy day, can be used for kids college, can be used to buy a new car, can be used to fund a vacation, can be used to fund retirement, can be used for any number of things, and it's just a really powerful tool when used right.
Speaker 1:Beautiful, the big con that I just want to talk about. To address Abe's question. Here he goes what are the actual cons of this account? Well, the first con is, to your point, james, if people over-optimize and they go, you know what? I'm just not going to do the 401k yeah, I. You know what I'm just not going to do the 401k yeah, I know I'm in a high tax bracket. I'm just going to do the brokerage account. Well, the con is you actually would have saved a ton in taxes and it really didn't actually help your plan.
Speaker 1:Now, maybe it provided peace of mind, which you would argue is worth it. If you wanted to possibly switch careers, you might find there's more value in adding more rainy day funds, but on paper it might be financially not optimal. That's not the biggest mistake. The biggest mistake that I personally see is people who do really well with a single position, a concentrated stock, and I'll use my dad all the time. My dad crushed it. He bought Monster Energy, which is literally one of the best performing stocks of the last few decades. If my dad, if I, were to tell him, dad, I need you to go sell monster stock, he'd shoot himself in the foot and he'd probably cry because he'd just wonder what if it goes up. And I said, dad, I don't blame you, but do you want one company to dictate how many surf trips you take in retirement? He said no way. So the point here is it doesn't mean he needs to go diversify entirely.
Speaker 1:I'll hear people listen to our content, james, and go. I heard you guys say it's important to diversify, but I bought all Apple. Should I just go do that? Generally, it can make sense to do so over time, but what happens is people get attached to a single position. That could be literally a monster energy type investment or a Tesla or Nvidia. Sometimes it's an ETF where you've held VTI for a very long time and you don't want to sell it because of tax implications. So the con that I see is people are not going and actually using these proceeds to do something because of the tax liability which, once again to your point, james, doesn't make sense. The point you saved or invested well is to use it, but it doesn't always mean it's easy. Yeah.
Speaker 2:A few other cons. The same way, there's a psychological benefit to having this account. The psychological downside is, with a 401k just automated, you tell your 401k provider I want to say 5%, 10%, 15%, whatever it is. It just happens and that money is out of sight, out of mind, the brokerage account, that's money that's hitting your checking account or it's hitting some account that you have. You typically now you can automate this, hopefully, but you could spend that. Sometimes people say, oh, the 401k that's out of sight, out of mind, I would never think to spend it. But everything else that comes in we spend that on our lifestyle. So it can be a bit more difficult in terms of just you don't have the true automation almost like barrier between you and your money like you do with a 401k. That's one. The other is taxes. If you don't manage it well, if you're constantly kind of buying and selling stocks and you're triggering short-term capital gains, it's going to be horribly tax inefficient and you're going to be paying the highest tax rates for doing that. That's not going to be good. So I think there's some psychological downsides plus real downsides if you don't manage it well. But if you can automate it, if you can control how much you're saving or something like that.
Speaker 2:This is where asset location comes in. We talked about the importance of having the right types of stocks and bonds and cash and real estate etc. To hold in your portfolio. You don't necessarily want every single holding that you know you should own in every single account. Your brokerage account, for example, maybe holds more tax-efficient assets. The assets are going to be taxed at long-term capital gains rates, whereas the tax-inefficient investments maybe you're going to prioritize having those held more in your IRAs or your Roth IRAs. So there's more that goes along with it. But overall, if managed correctly, it can really compliment a really good plan and give you what we talked about that flexibility, that optionality in your non-working years, or even in your working years, if you choose to use it. Then yeah.
Speaker 1:So if you go call up Vanguard or Fidelity or Schwab and say, hey, I heard these guys on this podcast. They talked about the superhero, go set it up for me. They'll be very confused because it's, once again, not a real account. But this is something that is a tool Doesn't mean you need to use it. It's just another tool and it's something we strongly consider you to look at and go. Would it help my individual situation I know many of you have shared. Hey, it's something I just didn't even consider and now I'm going to start looking into it. Others of you have said I've had it a long time. This whole episode just validated how brilliant I was to get it Awesome.
Speaker 1:We want to give you as helpful as information as possible. Once again, nothing should be taken as financial advice today. This is what we help clients with. So if you want to get an individual plan to understand how you can optimize and really withdraw income in the most efficient manner to minimize not just a single year of tax liability but over the course of your lifetime, that is really where we love to help clients so that you can go. Yep, I have multiple accounts. I know I'm doing as best as I can, so I can take that extra trip, or I can help that kid with a down payment, or I can retire a few years earlier. So, once again, you can reach out to us at our website, rootfinancialcom. In the upper right you'll see a button that says see if you're a fit. You can click on that and we look forward to hearing from you. Thanks James, thanks everyone.
Speaker 2:See you soon, see ya you.
