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Hold Your Assets in the Right Place – Investments in Retirement v Non-retirement Accounts

April 7, 2022

Not only is it important to understand the different types of wealth-building accounts but to understand what kinds of assets should be placed in each one. This article will explain the differences between retirement accounts (401k’s, 403b’s, IRAs, self-directed IRAs), Roth retirement accounts, and non-retirement accounts, and why you should hold different types of assets in each.


“Retirement” Versus “Non-retirement” Accounts


Let’s start here, even if it is an odd way to start: Money is money. It’s used to fund your life while you’re earning money and when you are not. In your financial world, you are allowed to earmark money for a particular purpose, such as retirement, whether the financial services industry registers that account is a “retirement account” or not. Brilliantly, one client called hers “my safety accounts” — accounts she has for when she needs money, which will most probably be when she is no longer working for a paycheck.


Where folks get twisted up is when financial professionals and institutions use “retirement accounts” to denote accounts like 401ks, 403bs, 457 plans, 401a plans, individual retirement accounts, and their Roth counterparts. Then they use phrases like “individual account” or “joint account” or “trust account” to denote every other kind of account. The technical then collapses with the colloquial and everything gets more confusing. Investors think, “What? I can’t use my brokerage account to fund retirement?” Of course, you can.


But there’s been so much emphasis in the financial retail markets on “funding your retirement account,” that the general public has been trained to want one or several of these. Job seekers are trained to ask if the employer if a retirement plan is provided and if there’s a match. Legislators make them mandatory. Investors love to hail or complain about them at cocktail parties. But there is no requirement that you own one. Plenty of people fund their retirements quite well without one.


Most people have a combination of “retirement” and “non-retirement” accounts as the financial industry would categorize them. If you are earmarking money in an account for a particular purpose, that’s totally fine and your business. What’s critical is getting the right investments inside the right wrappers.


Think About Money as Candy in a Wrapper


This analogy helps. Think about money as candy in a wrapper. The candy is the juicy morsel that gets you things in life that bring you nourishment and joy. The wrapper is the tax consequences of unwrapping that candy and setting that juicy morsel free. The tax implications change with the wrapper. Let’s take non-Roth retirement accounts, Roth retirement accounts, and non-retirement accounts in turn.


Non-Roth retirement accounts have ordinary income wrappers and lots of rules.  Non-Roth retirement accounts are your employer retirement accounts (most commonly 401ks, solo or individual 401ks, 403bs, 457s), your individual retirement accounts (IRAs), and your self-directed IRA accounts. They share these characteristics: They are funded with pre-tax dollars, the money grows tax-deferred, when money is withdrawn it is taxed at ordinary income rates (as if you can earned it on your job, with only one exception), if it’s withdrawn before 59.5-years-old it’s also penalized, and you must start taking money out at 72 years old because the governments want their share (and the governments always get their share). Pass these assets to beneficiaries and they will pay the taxes due.


Roth retirement accounts have tax-free wrappers and fewer rules.  Roth retirement accounts were named after the US senator that championed their creation. Most employer retirement accounts, IRAs, and self-directed IRAs have a Roth counterpart. They share these characteristics: They are funded with after-tax dollars, they money grows tax-deferred, and so long as you wait until after 59.5 years old to withdraw money, the money is not taxed. Withdraw it before 59.5 years old and pay penalties. There is no requirement to pull money out at any age. If you pass these along to beneficiaries, they do not pay taxes, either.


Non-retirement accounts have mixed tax wrappers and few rules.  Non-retirement accounts share these characteristics: They are funded with after-tax dollars. They are considered “taxable accounts,” which you can think of as “taxes happen on sale or income transactions.” What kind of tax you pay depends on the type of money you made. If you own dividend-paying stocks, those dividends are taxed, typically as ordinary income when you receive the income. If you own bonds that throw off interest, you also pay ordinary income taxes on that income unless those taxes are waived at the federal or state level or both (e.g., municipal bonds).


If you buy a stock, it grows in values, and you sell it, you are taxed on a capital gains basis (long- or short-term). Buying and selling an asset in less than a year’s time is taxed at short-term capital gains tax rates, which is typically the same as ordinary income rates. Buying an asset and selling it after a year and a day is taxed at long-term rates, which is often lower than ordinary income tax rates.


You will often hear advisors call non-retirement accounts “taxable accounts,” as if the other accounts have no taxes due. What they’re really referencing is the lack of the tax deferral feature that retirement accounts have, which arguably allows those accounts to grow bigger faster. In non-retirement accounts, investors frequently realize gains and have to pay the corresponding taxes each year. But unlike investments in retirement accounts, investments in these accounts can get a step-up in basis at the death of the owner, which can be a huge benefit to a beneficiary (potentially no capital gains taxes to pay upon immediate sale). That’s a huge benefit of non-retirement accounts.


Get the Right Candy in the Right Wrapper

Now that you understand the tax implications of these various accounts, or wrappers, you can now wisely place various assets in each.


Generally speaking:

  • You want assets in your retirement accounts (regular and Roth) that have frequent transactions or may be taxed at high rates. If they’re going to be taxed at high rates anyway, put them in retirement accounts.
  • You want assets in your non-retirement accounts that have low tax rates. This would include assets like stocks that have not been sold, interest-bearing bonds, and municipal bonds.
  • Self-directed IRAs are useful for “non-traditional” assets like real estate, businesses, or cryptocurrency. This is a topic to itself, but for now they’re included under the umbrella of retirement accounts and shouldn’t be left out.
  • Roth accounts are particularly great for highly volatile assets like cryptocurrency (held inside a self-directed Roth IRA). At asset price peaks you can withdraw money without paying taxes if you’re over 59.5 years old.
  • “Tax-sensitive” funds — those that are managed to minimize taxes — should be held in a non-retirement account, where you need the tax sensitivity, not inside a retirement account where you’re going to pay ordinary income taxes no matter what.
  • Tax-free bonds should also be held in a non-retirement account because there’s no taxes to be paid. Think about it: if you put a non-taxable asset inside a retirement account and withdrawal money, you’ll pay taxes on that income. Makes no sense.
  • Individual stocks can be held in retirement or non-retirement accounts. Choose the one where you get the best tax benefit. Going to sell in less than a year? Retirement account wrapper. Going to hold for a while? Non-retirement, taxable wrapper might be the better choice.


When you are reviewing your account statements, look at what you own, think about the tax implications, and reallocate to get assets (all that yummy candy!) into the right wrappers.


Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

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