Is Your Retirement Savings a Ticking Tax Bomb?

Whether you are an executive, professional, entrepreneur, or busy raising a family, there is something those who get the most from their savings have in common:  a brokerage account.  In this article, we will explain why this is the case, and more importantly, how to start saving in a brokerage account.  The good news is there are several ways you can do this and join the group who get the most from their savings. 

We all hear the message, “Save for retirement,” and naturally, we do so in tax-deferred retirement accounts, such as a 401(k) or 403(b).  This makes saving easier, because your contributions reduce the taxes you pay today.   However, while these accounts should be a major part of your retirement savings, they should not be the only part. 

Let’s say, you have $1 million saved for retirement, all in a pre-tax 401(k).  Now, assume in retirement, your combined federal and state effective tax rate is 25%.  How much of your savings is available to spend?  Hint:  it is not $1 million.   Since this money has not been taxed yet, every dollar you take out will be subject to tax.  Now, here is a subtle but important point.  When you use money from a tax deferred retirement account, you owe ordinary income tax on both your contributions and the growth.  This means there is a large tax liability imbedded in your savings.  In this case, $250,000 of your $1 million is earmarked for taxes, leaving you with $750,000. 

So, how do we shrink the part earmarked for taxes and increase your share?  A brokerage account and a Roth retirement account are two ways to accomplish this.  An Apella Financial Planner can help determine which one is best for you, but for this article, we will focus on the brokerage account.  When you use money from your brokerage account, you only owe taxes on the growth (not your original contributions), and the tax rate is typically lower than the rate on tax deferred retirement accounts.  In other words, a smaller portion of your money is subject to tax, and a lower tax rate is applied to the part that is taxed.  It’s a double benefit. 

There is also another benefit to a brokerage account.  With retirement accounts, there are restrictions on when and how the money can be used and tax penalties apply if they are not used correctly.  Brokerage accounts, on the other hand, do not have any restrictions, and the money is available anytime you need it.  This makes brokerage accounts an important resource, especially if you want to retire early or if life throws a curveball. 

Now, the question is how to build a brokerage account.  A simple way is to set up an automatic monthly deposit, paying yourself first.  A common (and costly) mistake is spending first and trying to save what is left over.  Save first, and spend what is left after savings and taxes.  It is ok to start small.  The important thing is to start.  Over time, you can increase the amount or make one-time deposits, when you receive a bonus. 

While automating your savings is effective, there are several other ways to fund a brokerage account: 

• Company stock grants:  If you are an executive or professional, part of your compensation may include company stock (restricted stock, stock options, etc.).  Receiving company stock each year can result in a concentrated position in your employer’s stock.  This increases your financial risk, because your salary already ties a large part of your financial position to your employer.  Selling some of your company stock, as you are able, is a great way to reduce risk, diversify, and build up a brokerage account.   Consult your HR team for any trade restrictions.  Together with your Apella Financial Planner, you can discuss the tax and ethical considerations and create a plan to build a diversified brokerage account. 

• Sale of a medical, legal, or CPA practice:   As a busy doctor, lawyer, or CPA, you have likely been occupied with the hustle and bustle of your practice.  However, as you approach retirement, you will begin thinking about your succession plan and who will take over your practice.  When you sell your practice, this creates an opportunity to place some of the proceeds into a brokerage account to help fund your retirement. 

• Sale of a business:  If you are a serial entrepreneur, growing a business, selling it, and starting the next one can be an irresistible call, but selling a business is also an opportunity to set aside some of the proceeds in a brokerage account.   This helps diversify the risk and builds liquid savings for future needs. 

For many, deciding how and where to save is confusing and complicated.  Including a brokerage account as part of your savings helps manage your long-term tax liability and provides added flexibility.  Optimizing the savings you worked hard to accumulate and creating a financial plan aligned with your values are just a few ways we help clients get the most use and fulfillment from their resources. 

Disclosures:   

Apella Capital, LLC (“Apella”), DBA Apella Wealth is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered or excluded or exempt from registration requirements. Registration with the SEC or any state securities authority does not imply a certain level of skill or training. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, product or any non-investment-related content made reference to directly or indirectly in this material will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions. Please note the material is provided for educational and background use only. Diversification seeks to improve performance by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market. Past performance does not guarantee future results. All data is from sources believed to be reliable but cannot be guaranteed or warranted.  

No current or future client should assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice. As with any investment strategy, there is the possibility of profitability as well as loss.