Deep Dive: Taxable Brokerage Accounts | Ep 549
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Hello and welcome to choose a five today on the show. We have our good friend, Cody Garrett back again for another deep dive. This one is actually going to be on what we consider the most underappreciated account type, which is the taxable brokerage account. We're often trying to optimize for taxes and do everything right. Fill up certain buckets for 401ks, four 57s, our IRAs, et cetera. But we often miss this really incredible account type.

And we just don't consider it. But the taxable brokerage account is a really important part of what Sean Mullaney, our other good friend, would call the compelling three. And this is a really important leg of that stool. So Cody put together an incredible outline for this deep dive. I think you're really going to enjoy it. And with that, welcome to Choose FI.

Cody, welcome back to Chooseify. I always love having you here. I always love being here. Thanks for inviting me back every time. Yeah. Well, thank you for coming up with the great idea for the episode. So I'm just going to turn it over to you and we'll do our normal thing, which is you're going to essentially drive this and I'll come in, I'll summarize, I'll ask some questions and such. But why don't you get started with really what you teed up as the most underappreciated account type?

Absolutely. So as the intro mentioned, on the path to and through early retirement, or just retirement in general, we're so focused on optimizing that accumulation order of operations. You call it that bucketing of, I'm going to fill up my 401k, 403b, 457, my HSA, IRA, all these alphabet soup. And then we kind of get sad, either if we max those out and we're like, what's next?

And then we kind of lack excitement because we're like, oh man, there's no other opportunities. Or we say, oh, I make too much money to contribute to an IRA or I'm not covered by a high deductible health plan. I don't have an HSA. What do I do? It's so sad, right? But today we're going to be talking about one of the most underappreciated investment accounts, literally called just the taxable brokerage account. So this is something that's accessible to everybody investing, whether you have earned income, whether you're retired,

Even miners can invest in these types of accounts. So we're going to do a deep dive today. Hopefully I'll not be too long winded because I love this stuff. But today we're going to be talking about the taxable. I guess we'll just call us a taxable account along the way. And Cody, let me just jump in. This is actually the worst part about this account is that we still have not come up with a satisfactory name for it.

That's really the hardest part. So yeah, taxable account. Tell us what it is. And then maybe I'll give my definition. Yeah. So my definition of a taxable account, again, a funny name. It's a non-retirement account where the investment income, the earnings within the account, right, such as interest, dividends and capital gains. Those are all taxed in the year it is earned, regardless of whether you withdraw cash from the account or whether you reinvest those dividends or not.

So I consider these accounts taxable along the way with my quotation marks. So taxable along the way. So whenever you see the word taxable, sometimes we think, oh, like when you take money out, it's taxable. No, no, no. Like take that away for a minute. You know, this idea is that these accounts are taxable along the way. But when you actually take money out of the account to pay your bills and have fun in retirement as you travel along the way, that income is not taxable to you when you take money out. It's just taxable along the way.

So we'll discuss that in more detail today. Yeah, that's a pretty good back of the envelope. So taxable along the way. The way that I try to really summarize this is, look, this is just your regular savings.

In essence, sure, you can put money into, as Cody said, the alphabet soup into the 401ks and the IRAs and all those things. But realistically, at the end of the day, you just have savings. Most likely you have some extra money. We all, hopefully as part of the FI community, have a really robust savings rate, right? So every month money comes into your checking account. Sure, some of it's already been funneled to your 401k and such, which is wonderful. You want to do that without having to think, but you have regular money coming in for your paycheck and then your expenses come out.

And money should continue to pile up, right? Like that money could sit in your checking account earning essentially nothing. You could put it in your freezer. You could put it under your mattress. You could put it in a high yield savings account. You could put it in bonds or you could open up a brokerage account at any brokerage of your choice, right? We probably would say, all right, Vanguard, Schwab or Fidelity would be probably my three choices.

But you could do wherever you want. And that's a taxable brokerage account because as Cody said, all right, look, this is your regular savings. You just decided to put that money into a taxable brokerage account where it's taxed along the way, right? You're not getting any benefits of able to shield that income that's coming in every year because...

Whatever it is, if it's in a high yield savings account, you're getting interest, right? And like that is taxable that year, as Cody said, taxable along the way. So you were getting taxed on that little bit, that interest. You're not getting taxed on the principal, obviously. It's just that interest earned. You'll get a 1099 for it at the end of the year and it goes on your tax return.

Okay. Regardless of whether you just rolled that money back in, that's hopefully what you're doing because that's compounding, right? Or in a better example, in your taxable brokerage account, you might get dividends. Hopefully you're reinvesting those and you don't actually see that cash come through. You don't have to make a decision. You just made that decision the very first time and said, click the box for reinvest dividends.

But rest assured, that's income you earn this year. Now, if that was in a 401k, you wouldn't get a 1099 at the end of the year because that's just part of how that account works. But in your regular savings, in this case, in your regular taxable brokerage, that is taxed along the way. So that's the distinction. Now, I know a lot of people get up in arms, Cody, about, oh, I have to pay tax. I have to pay tax. Give me a break. Right? Okay.

okay, this is the price of success. Would you rather sit there in a checking account earning nothing? Or would you rather pay a tiny little pittance of tax on this earnings and compounding along the way? So that's my own editorial of let's stop the belly aching with the tax. Obviously we try to control what we can control and put money in 401ks and other tax deferred vehicles. But at the end of the day, if you still have money left over and you're saving life is pretty darn good. My friend, it really is. Right.

Right. Yeah, I would say, you know, generally, not every time, but generally, you know, making more money is better than paying less tax, right? Especially with our progressive tax system that we have. Totally, totally, wholeheartedly agreed. So, okay, that's a taxable account. Now, Cody, where do we go from here? Yeah, so...

I'm always making social media posts about the top 10, all those catchy things. But today we're going to be talking about the benefits of taxable brokerage accounts. And I'm going to try to step back a little bit instead of just diving right into the benefit, kind of talk about like, why would we want this benefit? Like, why are we looking for this benefit? So I'm going to go ahead and start with our... Maybe I'll start with our little top eight. Maybe we can make it a little shorter today. We're actually recording this on Easter weekend. So we'll give a little bit more time to search for Easter eggs and do eight out of 10. So I want to start with this idea that, you know,

Our workplace retirement plans are 401ks, 403bs, 457bs, IRAs, HSAs. They all have contribution limitations. So they say you can only contribute this much annually. Well, good news, right? So when you run out of options to contribute to those accounts that are limited in your contributions, the taxable accounts, so again, your checking, your savings, your normal bank accounts, your taxable brokerage accounts, there are no annual contribution limits.

So, you know, you could contribute like, again, hopefully you're in this place someday where you can contribute a million dollars to your taxable brokerage account annually. Right. There's no annual contribution limits. So, you know, that's a huge, huge opportunity. And some people kind of call this like the residual or like the catch all account that once you're out of options, quote unquote, you're not actually out of options. You just say, OK, all remaining goes into this amazing account called the taxable account.

And I also want to mention, too, that unlike an IRA or a workplace retirement plan, you can even continue contributing to a taxable account without earned income. So an IRA requires that you have some form of compensation from W-2 wages or self-employment income. You don't need any income sources, quote unquote, to contribute to this type of account.

Right. And this is really important because there's really no contribution. It's not like nothing's happening. The way that I think about it is, okay, yeah, you've been accumulating. Hopefully you're not doing this, but let's like, this could happen under a scenario. You've accumulated $200,000 in your checking account and you're

It's just over the course of months and years and you've been saving and it's sitting in your checking account. You can do whatever the heck you want with that. I set up the ridiculous example. You could put it under your mattress. You could put it in your freezer or you could put it in a taxable brokerage account. It's your money. This is your savings. So I'm just trying to set the stage, Cody, because it's really important. People get so confused with this taxable brokerage account and it's unfortunate because it's just another place to put the money that you've already saved.

Yeah, I'll mention too that this idea that as soon as you receive income, it becomes an asset. Like, I don't know the timing of this. I mean, I guess it's constructive receipt as the IRS calls it. But effectively, as soon as you receive income, it is now an asset. And as soon as you turn an asset into income by having it leave your life, personal finance ultimately is accumulating, it's just turning income into assets, and then retirement is turning assets into income. So that's a very general framework that we can think about moving forward. Yeah.

I like that. I like that. Okay. So where do we go from here, Cody? Sure. So now that you can contribute unlimited, right? Just like you said, Brad, like hopefully you're not just contributing to a checking and savings account. Even with some of these, you know, quote unquote, high yield savings accounts, we want to look at what are called, you know, risk premiums of, hey, if I invest in the stock market or other types of investments, you know, I might have higher earnings in the future, especially long term. So number two benefit is investment availability.

We've all had those 401ks, 403bs, 457s that had limited investment options. They give you this mutual fund lineup. Hopefully there are some index fund options for our low cost passive investors out here. But one thing that's great about a taxable account is you're not really restricted to your investment options. So you can invest in individual securities, individual stocks and bonds, ETFs.

exchange traded funds. Yes, you can continue investing in mutual funds. Also think about it, right? Whenever you buy a house, right? Technically that is like a taxable asset. So, you know, buying a primary residence, your real estate, whether it's you're buying it yourself or you're buying REITs, real estate investment trust within your accounts. Crypto. So cryptocurrency is not usually offered as one of the mutual fund options, right? At a 401k. So you can invest in crypto. So if you have like a Robinhood account on your phone and you're buying, again, there's tons of different custodians out there, but

Whether you're speculating or actually investing for long-term growth, you can invest in pretty much whatever you want within a taxable account. I think my heart just broke inside thinking about, oh, please don't have a Robinhood account. But yeah, point well taken.

Exactly. Yeah. So as Brad mentioned, my favorite custodian, some people ask like, you know, which custodian should I choose? I would say my priority is Fidelity, then Vanguard, then Schwab. Fidelity actually wins out because they have HSAs for retail investors. And then Schwab on the bottom because they have a pretty poor portfolio.

the default cash position isn't very swell at Schwab, whereas it's a money market fund giving you a nice yield at Vanguard and Fidelity. Yeah, and that's huge. I mean, I've seen those money market funds, just the default, are better than most high-yield savings accounts that I've seen. So you could do a whole lot worse. If you wanted to have a high-yield savings, you could just park your money there. So moving on to number three, we're going fast here, hopefully. Yeah, we are. So the next is, we talked about this idea of being taxable along the way.

And some people are like, oh, boo-hoo, I ran out of options in all those other accounts. I'm going to dump money in here and invest. And I'm so sad, they're taxable along the way. Well, good news. Even though they're taxable along the way, the IRS has provided favorable tax treatment for investing in certain types of ways within these accounts. So you might be familiar with dividends, dividends and interest income, but qualified dividend income and realized long-term capital gains

are taxed at lower federal income tax rates than ordinary income. I'm going to back up there a little bit because we might be wondering, you know, just on the basics here, a dividend,

You might look at your tax forms from last year. A dividend is reported on form 1099-DIV, DIV for dividend. That includes qualified dividends that receive this preferential tax treatment we're about to discuss. And effectively, a dividend is simply a distribution paid out of a corporate's earnings and profits to its shareholders. When you own Apple stock, for example, a portion of those profits are paid out to shareholders. And guess what? Even if you own a broad-based, low-cost index fund, you're receiving a share of those dividends

along the way. So whenever you do receive what are called qualified dividends, primarily from US companies, we'll talk a little bit about asset location in a bit. But I want to share that those qualified dividends are taxed at those preferential tax rates, which we've talked about in a previous episode with tax gain harvesting. Brad, probably bring that up here. But effectively, those are taxed at 0%, 15%, or 20%, depending on your level of taxable income.

But I want to quickly talk here about the short-term versus long-term capital gains. So separate from qualified dividends, you'll also have short-term or long-term capital gains. And an easy way to say this is, I sold it for more than I bought it for, very generally. And if you buy something, hold it for longer than a year and then sell it,

with what's called a realized capital gain, so you sold it for more than you bought it for, that's going to be taxed at either 0%, 15%, or 20%, again, based on your level of taxable income as a taxpayer. And I want to mention just as a little sidebar that even though a long-term capital gain could be taxed at 0%,

that they're still included in your adjusted gross income. So just a little caveat here, if you are retired and you're trying to control your levels of taxable income, especially for those premium tax credits, which are the health insurance subsidies, keep in mind that even if you're taxed at 0% on your long-term capital gains, they're still included in your gross income used to

calculate how much subsidy you receive. Gotcha. Yeah, that's important. And that was episode 517. Cody, we did that entire deep dive on tax gain strategies. That was a really, really wonderful episode, incredibly well received. And yeah, that's something if you are listening to this and you haven't heard that episode, please go listen to it. It's an essential one. And yeah, Cody, it's interesting you're talking about the preferential rates.

Right. And this is this is actually what's really cool about these taxable brokerage accounts. Yet another thing is that, OK, yeah, I've described it as, all right, look, this is just your regular savings account in essence. But nevertheless, you still because of the type of income or in this case, a realized capital gain we're talking about.

Okay. The tax code is set up that really for investors, frankly, very beneficial for investors that if you've held this for more than a year, you get to sell it. And if you realize a gain at that point, so it goes from unrealized to when it's sold, it's realized that's the terminology. Okay.

And it's at this incredible preferential rate. And Cody, we described in episode 517 how a lot of people in the FI community can pay 0% on that up to a significant amount, somewhere in the $90,000 range. It's not worth getting into now. Obviously, we're in a different tax year, so we're not going to dive into the exact numbers. But I mean, listen, everybody, this is really important.

you can benefit wildly from this. And even for most people, you're only paying 15% on long-term cap gains. So even if you're not paying zero, 15% is still incredibly preferential as compared to ordinary income rates. So this type of income is distinct from your ordinary income, which is what's coming through on your W-2. Yeah, that's right. And just to journal, I know that some people are like, I want some numbers. Generally, I have the numbers here in 2025.

you could actually have a 0% long-term capital gains tax rate with adjusted gross income of about $60,000 single and about double that, about $120,000 married filing jointly. So again, those long-term capital gains are included in gross income. But just keep in mind that you can even have pretty significant income, especially in retirement, and still pay 0% on those capital gains. And I want to mention here this idea of controlling... When I sell investments...

Let's say that every month I put a thousand bucks into my taxable account over time. And as dividends come through, they're automatically reinvested. By the way, you actually have to go in and make sure that you're auto reinvesting. It isn't an automatic selection at most of these custodians. So when you're logged into Fidelity, Schwab, Vanguard, go ahead and type in reinvestment or dividend auto reinvestment to make sure you're actually investing those dividends if you intend to. But one thing is when you end up selling a security, you might say, well, I'm

I bought this investment over multiple months. So now I have dozens of what are called tax slots, dozens of purchases with different cost basis, which is the cost I bought it for and different realized gains. So one thing that's really important to think about is what's called a disposal method. So I can see that Fidelity actually offers 12 different options for disposal and Vanguard offers a handful on the side here. And when you go into your investments, if you want to be very specific,

about, you know, without going too deep into all the disposal methods, I'll just simply say that if you want to choose which lots you sell, let's say that you only want to sell lots that are at a realized loss. Again, we'll talk a little bit about tax loss harvesting possibly today, but there's something called a specific share identification.

This also goes by spec ID for short. That allows you to choose exactly which specific lots to sell, which is nice. It's time intensive. You have to do a little bit of research looking at all the different lots in your account. But if you're relying on any income-based benefits, or if you only want to sell things with loss, or only want to sell things that are long-term, not short-term, you can use specific share identification to decide which specific lots you want to sell. And without going too far here, some general ones that you might see on disposal methods are first in, first out,

That's called FIFO, right? So the shares you bought first are sold first. Thankfully that often results in a long-term capital gain, which is great, but it's most likely gonna result in the largest capital gain, especially if you've been invested for the last few years. The next is last in first out called LIFO. So again, the shares you bought last are sold first.

this often results in a small capital gain, which is great, but you're most likely selling something that's short-term, not long-term. So it's not receiving that same preferential tax rate. So again, there's, let's say 12 on Fidelity that we won't go into today, but just go ahead and check out those disposal methods that you're custodian of choice. And yeah, Cody, we clearly don't give advice on this podcast. That's not the way we roll, but I know personally, specific share identification is the one that I go for. It just gives me the most granular detail into my exact portfolio

tax lots. And that's another piece of terminology. Like there's nothing specific, like don't get bogged down in that. It's just every time you make a purchase in essence, it's called a lot. So regardless of whether you bought one share or a fraction of a share or 10,000 shares, it's just

you're making that one purchase. So all of the background information is the same in essence, like the share purchase price is the same, the date you purchase it. So for ease, these brokerages, they split them up into those lots. And this is also not to say that you need to dispose of an entire lot at

at the same time. You don't have to. So in that example where you bought 10,000 shares or even an example where you bought two shares, you could sell one of them if you wanted. There's no requirement that you do anything with these lots. It's just that's how it's broken up. And it just it gives you a lot more detail. And Cody, the brokerages I've seen Vanguard and Fidelity specifically, when you like click on

on that lot. You get to say how many shares or all of it you want to sell. And then it even tells you, okay, here's the long-term or short-term capital gain or loss. So it really makes it incredibly easy to use from what I've seen. Right. And I would say that I'm an over-optimizer, right? I literally have a brand called Measure Twice Quality Control. But

Let's say you want to reduce your return on hassle as a ROH. Instead of doing specific share identification, if you don't have the time, temperament, or talent to do that, the three Ts there, there's also something called a tax-sensitive or minimum tax disposal method at Vanguard and Fidelity that, again, just makes it, just say, hey, I'll just let them do what they think is the most tax-efficient and hopefully it will kind of arrive in the same place. Love it.

So we briefly covered selling something at a gain, but now I'm going to cover generally selling something at a loss. We call this tax loss harvesting, right? So if you sell something at a capital loss, so you sell something for less than what you paid for it initially, that can first offset other capital gains. And at the end of the year, if you have any net capital loss for the whole year, that can offset up to $3,000 of other income.

including ordinary income from other sources each year. And let's say you end up with a year, you have net capital loss of $10,000, right? So the first 3,000 of that can offset other income and the remaining 7,000 of capital loss carryover moves into the

following year. And that can offset future realized capital gains up to 3000 against ordinary income. And it's like your shampoo, right? Rinse and repeat. So every year, this keeps repeating until you're out of those losses. Again, hopefully we're investing for long term gain, but there are some fantastic opportunities

especially actually right now, again, I'm not giving you investment advice, but I actually logged into my accounts the other day. I actually sold some VOO, which is S&P 500 at a loss. Again, I selected only the lots with specific identification that were at a loss. I sold those and immediately bought VTI, which is the total stock market index with that cash. So I remained invested in the stock market, but I went ahead and locked in that realized loss so that I could offset some other income

this year. Yeah. And Cody, you know, I highlighted that video that you put in, in my newsletter. I thought it was fantastic. Yeah. Tax loss harvesting. Of course we never want to see a period as we're recording this, we're going through some wild gyrations in the stock market. Yeah. And right. If, if,

Again, nobody wants to see the market go down 5%, 10% in a day or two, but we maximize the best we can. And yeah, I mean, if you have unrealized losses, the cool thing is you can realize them. And as Cody's saying, a neat thing is people are generally concerned about, oh, I'm going to be out of the market or, oh, I have to worry about the wash sale rule, which basically says you can't

I'm paraphrasing, but you can't repurchase the substantially identical security in the next 30 days. It has to be over 30 days. So what that could mean is, oh, no, I'm out of the market for 30 days. Do I really want to do this? But as Cody just said, you could go from something like VOO, which is the Vanguard S&P 500 ETF.

into the VTI, which is the Vanguard total stock market ETF or vice versa. Really, the key point is even though the S&P 500 and the total stock market track

almost identically as far as returns go. They are not substantially identical securities. So you could theoretically, especially with an ETF, you could sell it. And then once that money settled, you could essentially rebuy the other one, just a few X minutes, hours, whatever it is later and get right back into the market. So you've realized the loss, but you're not out of the market.

So, I mean, Cody, that's a pretty cool scenario of, again, because the spec ID enables you to see these things, when you have this crazy volatility or a crazy drop, you can just log in, see all your lots, see where there's losses and just realize them and buy the other one.

Yeah. And that's a great thing about ETFs, exchange traded funds like VOO, VTI, is that they sell during the day. So I can trade those during the day. I literally sold VOO and then two minutes later, bought VTI without having to wait a day or two. I immediately had access to repurchase. And a quick thing here on the wash sale rule, those substantially identical, that definition is kind of gray area. First of all,

make sure, of course, it has a different ticker, right? So VOO, VTI are different ticker IDs. But also, I like to go a step further and make sure that they're actually investments following different benchmarks and have maybe a different number of holdings just so that if I were audited at some point, I could actually defend, hey, these are actually substantially identical and I could back that up. Yeah. And that is a great point. I'm glad you said that. So, right. We don't have tax case laws saying VOO and VTI are going to hold up in 100% of cases. I think it's

pretty well regarded that those are not substantially identical. And like Cody said, if you can defend it, then okay. But again, as always, I'm not trying to give a cop out here, but this is a podcast going out to many hundreds of thousands of people. We're not giving you financial advice. Cody and I are just talking how we would do this. We both

I'm speaking for Cody here since he said this, we both would feel comfortable going from an S&P 500 into a total stock market and feel that that does not run afoul of the watch sale rule. Yeah, send me your hate mail if you want. Yes, not me, not me. But as always, if that's something you're not comfortable with, okay, you could wait the 31 days or you could find another index to track if you want that's whatever you want essentially. So you always have to make the decision that works well for you. But Cody and I both feel personally in our own lives that

that runs on the right side of this. Absolutely. And I'll document my audit if they come after me. Yeah. Nice. Beautiful. Thanks for listening to Chooseify and for all your support of our mission here. The absolute best way to support Chooseify is when you sign up for your next rewards credit card to use our cards page at chooseify.com slash cards. I keep this page constantly updated, so it should always be the top resource for you. Thanks for being part of our community and for your support.

So moving past that, so you might have your gears going in your head. I'm thinking, okay, which type of investments do I want to hold in a taxable account to receive the most preferential tax treatment? And without going into too much detail here, because I love that stuff, the asset location priority, we call this tax basketing. Sean Mullaney is a big fan of that term as well, is...

effectively buying US stocks, especially those US stock index funds, for example, the total US stock market last year in 2024, about 90% of the dividends that it paid out were qualified. So those are taxed at that preferential tax rate. And also the US stock market has a very low dividend yield right now. So I think last year in 2024, it was about 1.3%. So what's kind of funny about this is, let's say you had $100,000 just

give or take in the US stock market index fund last year, it might've paid out $1,300 in dividends and only $130 of that was non-qualified. So you can see immediately because of the low dividend yield and also the high qualified dividend rate, that's a really nice thing to hold

Again, just generally not investment advice within a taxable account. And you might be saying, okay, well, I want to be globally diversified, you know, go kind of beyond the US. Let's say you have a global allocation, including some foreign stocks. So the total international stock market last year, about 60% was qualified dividends.

but also with a higher dividend yield of about 3.3% versus 1.3%. So you can kind of say, okay, well, US stocks are more favorable tax-wise holding those in a taxable account versus foreign stocks. So that kind of goes second in line. The reason they're actually second in line and not further down is that you might receive a foreign tax credit

for some of those foreign taxes paid on those foreign stocks. That's as far as I'll go on that. But next in line after foreign stocks, we have real estate. So you might be buying REITs, Real Estate Investment Trust. So the REIT index from Vanguard last year was 98% non-qualified, right? So you're like, okay, that's not good, right? 98% non-qualified. And it has even a higher dividend yield of 3.9%.

And again, that's number three. So you're kind of getting poor quickly here, but you can see that number three on real estate. One good thing about REIT dividends is that they can receive the 20% QBI deduction. Again, if you see that on your tax return, you might see that's called section one, 199A dividends.

or on your 1099-DIV, you'll see that. Form 8995 for the QBI deduction, a little bit beyond the scope today. But just think that if you buy REITs within a taxable account, you're gonna have a higher dividend yield most likely, mostly non-qualified. Yes, you will receive a QBI deduction, but keep in mind, right? A deduction is a coupon, whereas a credit is a gift card, right? So you're not really receiving maybe that much benefit.

from the QBI deduction. And then the last four and five on that list of priority, or really the lack of priority are government bonds. So government bonds actually being tax exempt on the state level, but still taxed fully on the federal level. And then corporate bonds, which that interest is the least favorable because that's taxed at ordinary rates, federally and state. So in that order, US stocks, foreign stocks, real estate REITs,

government bonds, corporate bonds. And I also just quickly want to mention that the BND, which is the total US bond market index from Vanguard, last year had a dividend yield of 3.6%. But that was all non-qualified. So where I'm really going here is that I typically, again, not advice for you, but I typically advise clients to think about holding, if possible, their fixed income within their tax-deferred retirement accounts, such as the traditional 401ks, traditional IRAs,

things like that, and really beefing up as much as possible. Again, assuming they have the risk tolerance, risk need and risk capacity to hold their stocks within their taxable accounts. Sure. And that intuitively makes sense, right? So those type of securities or investments, you're getting them to spit off income.

in the current year most people are and therefore you don't want them ideally in a perfect world this is not to say don't do it but it's just say if you have the option to bucket your investments in a certain way you don't want these investments that are spitting off a whole lot of income in your taxed along the way account right it's just kind of common sense so

That's why, yeah, on Cody's list of asset priorities, yeah, more likely than not, your U.S. and foreign stocks are what you're going to want to put in your taxable brokerage account. Ideally, the bonds you're going to have in a 401k or that type of account.

Right. And a quick caveat here that diversification is more important than tax optimization. So if you don't have enough room or flexibility to move your bonds, your cash fixed income into pre-tax accounts, like make sure you're really prioritizing diversification across your total portfolio first. And then saying, do I have an opportunity to be more tax optimized with what's called asset location? Yep.

Love it. It's the don't let the tax tail wag the dog, right? Don't make decisions based on tax. In an ideal world, if everything else doesn't fall into line, of course, if it does fall into line, then of course you want to think about this. It's absolutely essential. But let's get priority straight first, as Cody's saying.

That's right. That's right. So thankfully, we can contribute as much as we want to these accounts. They're taxable along the way, but thankfully with a lot of preferential tax treatment with those qualified dividends, long-term capital gains. And when we want to take money, actually cash out of the account, we can do that.

Think about when you go to the bank, right? When you go to the bank and say, hey, I want to take a thousand bucks out in cash. They don't send you a tax bill for that, right? So whenever you take a cash withdrawal from one of these accounts, a taxable account, they're tax-free withdrawals. So while earnings are taxable along the way, those withdrawals are excluded from gross income, right? So again, just like you go to the bank and take money out. And again, that's really nice compared to whenever you take money out of a traditional 401k, IRA, you

or even HSAs, you have to worry about making sure that the taxability is not only reported correctly, but taking money out of a traditional retirement account. Every dollar you can take out most likely will be taxable as ordinary income. Absolutely. And yeah, this is really important. So again, that mental framework of this is just your savings.

OK, it could be sitting under your mattress or in this case, it's sitting in your taxable brokerage account. So there's no taxability for pulling that money out of. Now, that is different, obviously, as we've discussed, Cody, if the money is sitting in your taxable brokerage and it's in a stock or a security and you have to sell that security. Right. Right. Then, of course, that realized gain capital gain in that scenario is taxable.

But once the money is then sitting in cash, you can do whatever you want with it.

You can pull it out. That's not the issue. So there are people who, like we talked about with Fidelity and Vanguard, your high yield savings account, you could just use your brokerage account instead of a high yield savings. Let's just say, hypothetically, you had a big cash cushion. You had a hundred grand just sitting in there earning whatever it is now about 4%. Well, that's wonderful, but you could pull that hundred grand or any portion of it back to your own checking account at any point. This is your money. There's no implications. There's no

Like as Cody said, there's a tax-free withdrawals. You can do whatever the heck you want with that money. Right. And I'll say, as long as you're not using a robo-advisor where they're making the trades for you, if you go into Fidelity and say, I want $100,000, like they're going to say, hey, there's not enough cash available. And they're going to make you make that taxable potentially trade to gain access to the cash. So yeah, usually trading and then withdrawing are two different actions that you're going to be taking. So yeah, that's a great point, Brad.

So now moving to the fifth benefit of taxable accounts, we have no age-based rules. So of course, there's no contribution limits as we talked about, or you don't have to be a certain age to contribute or take money out, but you're also never forced to take money out based on your age. So something we learn about with traditional retirement accounts is that they have these things called required minimum distributions, RMDs, starting in your kind of mid-70s.

But thankfully, they don't force you to take any money out of a taxable brokerage account or even sell investments at a certain age. And in early retirement, there's no such thing as a 10% penalty for taking money out before age 59 and a half. So especially for the early retiree, your ears perked up a little bit. You're like, wait a minute, I have...

penalty-free access to an account. So the taxable account is fantastic for, especially that bridge between early retirement and when you reach 59 and a half, if you're not utilizing some of those early distribution strategies that Sean Mullaney talks about, like SEPP, rule of 55, and those other tactics there. Yeah, I love it. This is pretty clear. This is your money. There are no rules in essence. So yeah, that's great.

I love it. I love it. So moving to number six is gifts to others. And I like to split this into two halves, right? So you can transfer taxable assets to either other investors. So, hey, Brad, happy birthday. I'm going to gift you some VTI. Or I can give those shares directly to qualified charitable organizations without triggering income taxes for either party.

So let's say that I want to give one share of VTI happy birthday to Brad. Thankfully, since I'm not selling anything, I'm just transferring it to Brad. I don't have to pay any taxes on, there's no realized capital gain. And I'm giving that to Brad. And let's say that it's appreciated. I bought it at 100 and now it's worth 150. I give it to Brad. Brad sells it. If he sells it still at a gain, it's going to have what's called a carryover cost basis and carryover holding period.

which means that Brad's cost basis will also be $100 as if he bought it when I bought it. And the holding period is the same as effectively mine plus his holding period. So if before I gave it to Brad, it was at an unrealized long-term capital gain, and I give it to Brad, he sells it the next day, he still gets that long-term capital gains tax treatment. So this is a fantastic way that I've seen, especially retirees actually giving money

to their adult children, independent adult children who might have a lower long-term capital gains tax rate than they do, right? So effectively, they might be able to give the same gift, but paying less taxes, more money to the person they want to give it to and less money given to the IRS.

Oh, that is really interesting. Now, Cody, I'm assuming this type of gift would still fall under the gift tax rules, the annual exemptions and the lifetime exclusion on gift tax slash estate tax. So you do have to keep it under a certain amount every year, but that's a pretty generous amount. And if it is over that amount, you just report it on this gift tax return. There we go. There we go. Yes.

Yeah. So when I said, you know, without triggering income taxes, keep in mind that you might trigger the need to file a form 709 if you give more than 19,000 per donor per recipient. And Cody, it's important to note that almost nobody here will pay gift tax or estate tax just based on the

massive, massive, massive exclusion that exists for the lifetime here. So it's only a matter of just documenting, but realistically $19,000 per person per recipient. So if you were like in your example of parents giving to their children for the house purchase, right? Yeah, right. Exactly. And let's say, yeah, they were giving to a son and a daughter-in-law, right? So mom,

could give 19,000 to the son. Mom could give 19,000 to the daughter-in-law. Dad could give 19,000 to the son and another 19,000 to the daughter-in-law. And that's without triggering any type of reporting requirement. That's the beautiful part here. So as long as you're under that amount, that's your annual amount. And it doesn't go on this lifetime kind of, I think of it, Cody, as like, it's just a running tally, basically. Of, hey, if you could give more than the 19 grand each person, if you wanted to in a year, then you just have to keep tally of it.

on this form. So no big deal, but it's just important to understand. That's right. So we've given money to our friends and family. Now we're going to give money to our favorite charitable organizations. So first of all, I would say that if you have a taxable brokerage account with a lot of unrealized capital gains, if you're giving to qualified charities with cash,

Stop. Pause. I'm not going to tell you what to do, but think to yourself, hey, maybe instead of giving cash, I have the potential to actually give appreciated securities directly to charitable organizations instead. And what that means is either transferring it directly to the charity, they might have their own investment account set up if it's a larger charitable organization, or by using what's called a donor advised fund.

This is a centralized account that you set up where you transfer cash and securities into a... It was really an irrevocable gift for tax purposes. And what's nice about that is whenever you give, even if you don't itemize your deductions for a minute, even if you can't itemize, if you're giving it directly to charity, you just kind of erased those future realized capital gains from your life. And the cash you would have given to charity, you can simply buy that same security that you just gave away.

and effectively resetting the cost basis, right? So even if you're not itemizing your deductions, just think about, hey, does it make sense to like, you know, give to my local charities or national charities with appreciated securities rather than giving them cash from my bank account? Yeah.

And the critical piece, and a couple of people have emailed me about this, calling me out like, oh, are you just screwing over the charities in this case? No, come on, people. Let's be clear. Do you think that Cody and I would be giving that kind of advice to let's stick it to the charities that we want? We only stick it to one organization, right? Yeah. So Cody talked about the carryover basis when you gift to another normal human being. That's true. But when you gift...

appreciated stock to a charity, they are not paying that unrealized capital gain. Okay. So if you give them a thousand dollars in securities, let's just say Cody, you know, to give an example, right? Like you bought this stock for $200 20 years ago. It's now worth a thousand. You want to give this charity a thousand dollar contribution. Most people who don't realize that you can do this would

Well, A, they'd probably just give $1,000 from their bank account. But let's just say this was the only money they had. They would sell that security. They would then have to pay long-term capital gains on the $800 of realized gain now in this point. That's right. So that would probably most likely be 15%, so $120 in tax, right? So they'd actually net $880. And now if this was all their money, they would actually only be able to donate $880, okay, in that scenario. Now-

realistically, what happens because of this beautiful ability to donate appreciated securities is they could just say, I don't have to sell this. I can just donate the thousand dollars in securities that $800 in unrealized capital gains for me.

is vanished forever. It is a permanent change. It's a permanent reduction. I never have to pay that. I've now handed a thousand dollars in securities to my favorite charity and they can sell it and get the thousand dollars cash and they don't pay any tax. Okay. So there's no realized capital gain. There's no capital gains tax for the security. So everybody take a deep breath and just know that this is a wonderful strategy, both for you and for the charity.

That's right. I call this legally giving more to charity and less to the IRS. And by the way, the IRS encourages this. It's not something where you're, again, like you said, stick it to the man. This is an opportunity to do what the IRS actually encourages by providing these carve-outs in the tax code to give to charity in a tax-optimized manner.

So moving from number six to number seven, we have the step up in basis. So if you die with investments within a taxable account, those investments will receive what's called a step up, a reset in cost basis. And that's going to be reset to the fair market value as of the date of death. So effectively, that means that let's say...

I die with a lot of appreciated securities and Brad is my sole beneficiary. Happy birthday again, Brad. Thank you, Kevin. So that would mean that Brad could potentially, as soon as he inherits that account, again, let's say I bought that $200 and it's now worth $1,000. Now the cost basis is no longer $200. It resets to $1,000 as of the date of death. And if Brad sells that immediately, he could actually have a realized gain of potentially zero. So little or no tax consequence for the beneficiaries.

And one little fun thing here is that if you're in a community property state, if you own assets with a spouse jointly, both halves of that property held by a married couple can receive the step up in cost basis, not just the deceased spouse's half. So you might be in a common law state or a community property state. Definitely Google, see which one you're in. Have a little fun with ChatGPT on that.

But one thing that's really important here is that don't assume the investment custodian will automatically adjust the cost basis when they're notified of the death, right? So here I say measure twice. So if you've inherited money from, let's say a family member, your parents, for example, and from a taxable,

asset, just make sure that when you inherited that property, you received that step up in basis because you don't want to end up paying taxes as if you bought it when your parents bought it. It should be stepped up to that date of death. Yeah. And this is yet another thing. We talked about the lifetime exclusion for gift and estate tax. People get so worked up about the death tax and all this other stuff. And it's like fleetingly few people pay even $1.00

in estate tax. And actually, like Cody's saying, we get showered benefits. So in this case, those who receive the money after someone passes, they don't even have that unrealized gain built in. There's no built-in gain anymore. You get a step up in basis. So as if you bought it on the day of death, you could sell all those securities and you

you pay i mean assuming you sold it at that exact instant you would pay literally zero right of course in real terms it would take a couple hours a day whatever it may be so you might have a tiny little baby gain or loss but in realistic terms there's

essentially no tax implications upon death for the recipient in virtually every case, virtually every case. There are fleetingly few instances. So another thing of just, you know, take a deep breath. This is why we learn. This is why Cody comes on and does these deep dives because it's essential that we all understand this. And when you have understanding, you have a lot less fear and anxiety as well.

Yeah. And you might be wondering, hey, does every type of account receive a step up in basis? I'll say it's really just the taxable account. So if you have if you inherit a 401k, an IRA and HSA, right, that's considered income in respect of a decedent IRD income. And effectively, you know, for most people, if you're inheriting money from your parents, for example, on a traditional IRA, you're most likely going to have to distribute all that money within 10 years.

as ordinary income. Again, no step up, right? All those earnings were deferred along the way, and you're going to have to take out, really effectively empty out that entire account within 10 years. We won't go into the RMD rules here and all that stuff, but just keep in mind that the step up in basis is a massive opportunity for taxable accounts that isn't available in the other accounts. And also the worst account to inherit from a non-spouse is an HSA. Actually,

actually. A health savings account, if you inherit an HSA from a non-spouse, it becomes effectively not an HSA as of the date of death. And you have to distribute all of the money out of the HSA as taxable income within the year of death. So that's one of the worst accounts to inherit and the best account to inherit, I would say, is the taxable account and the Roth IRA.

So moving to number eight, account titling. We've been talking about estate planning, the simplification and the step up in basis. One great thing about a taxable account is unlike retirement accounts and HSAs, which have to be individually owned. When you see IRA, that's individual retirement arrangement. The taxable accounts can be titled with multiple ownership structures. So you could own it joint tenancy with right of survivorship. That's what you might see JTW ROS. That's typically with a spouse, right? Or somebody you want to have like equal ownership.

in an account with somebody else. We have tenancy by the entirety, also TE. That's only for married couples and it's only recognized by some states. We have payable on death and transfer on death. That's a way to effectively add beneficiary owners to an account. So if I pass away, if I add, again, I'm just giving Brad all my money in this episode today. I love this, Cody. Thank you. Yeah. If I have an individual account, but it's titled POD or TOD with Brad as the beneficiary,

Upon my death, that asset will actually pass directly to Brad without having to go through the will, the probate process. A great way to simplify estate planning. So POD, TOD. And then lastly, something parents like to do, I'm not a big fan of actually, is using custodial accounts. We call these UGMAs, UTMAs for minor children. And this is a way to make an irrevocable gift to a minor child's account and kind of say, hey, let me teach them how to invest

I guess up to you, Brad, if you want to go more into detail here, but it's just really nice to be able to title these accounts any way you'd like with different ownership structures. Yeah, I think that's great. It's just, it's flexibility, right? And of course we can't go into every single one right now, but just understanding that you have these options like Cody just laid out. Okay, that's great. So you look at, hey,

What type of state am I in? And just Google that. You now have the information you need to run from here. Sure. All right, Cody. So I think that basically comes to an end of your entire outline here, which is absolutely wonderful. I know one thing you wanted to talk about to close this out was your rough order of operations for the different types of accounts when it comes to essentially tax optimized accumulation.

That's right. So when you're contributing, when you're again, you're making money and you're able to contribute to these accounts, we talk about, you know, some people show the visual of the buckets spilling into the buckets spilling into the bucket. So some people ask, hey, when should I prioritize using taxable accounts instead of these other types of accounts? So first, the tax optimized account.

accumulation order of operations is starting with contributing to your workplace retirement accounts. A lot of us in the early retirement community are contributing to traditional, trying to get that tax deduction up front and potentially have a lower marginal or effective tax rate in the future. So effectively, it's contributing enough to get that employer match. Some people call it free money. Think about your money in terms of time. You're not just getting free money, you're getting free time in retirement by contributing up to the full match. Next in line is not available to most people, but the ESPP

employee stock purchase plan. If you're a tech professional, you might be able to contribute to take advantage of stock discounts by purchasing stocks of your company. Make sure you diversify prudently, of course. The next in line is the HSA, the health savings account. So those contributions through payroll reduce income and employment taxes while offering that tax-free growth for qualified medical expenses. So I always like to take advantage of the tax-

benefits of that. Next in line is actually returning back to the workplace retirement accounts, those 401ks, 403bs, and 457s. So you most likely want to max those out for the remaining elective deferrals. Next in line, again, we're talking about tax optimization here. Next in line is the Roth IRA. So contributing up to the annual limit using either direct or backdoor Roth strategies. And hopefully if you're doing backdoor, trying to avoid taxable Roth conversions there.

And then next in line is actually doing workplace retirement accounts one more time, which is only if your 401k or 403b offers something called after-tax non-Roth contributions. This is also called the mega backdoor Roth. But again, not every 401k offers this, but if you're able to make those additional

after-tax mega backdoor Roth contributions and convert them immediately to Roth without tax consequences, that can be a massive way to contribute. But then you see here, again, even though it's last in line, my favorite account is the taxable brokerage account. Those taxable accounts we discussed. So invest the remaining savings for flexibility and preferential tax treatment. And you might be saying, okay, well, it's last in line. Like I probably will never get there.

But think about the difference between tax optimization and flexibility. And how do you prioritize those things? So let's say that I want to buy a house two years from now, and I'm not even close to having my down payment ready. I might say, hey, I'm going to get my employer match, do my HSA, but then I'm going to drop to number seven, which is taxable brokerage accounts. I'm going to skip some of these so that I can build flexibility. And keep in mind, there's a difference between liquidity and stability.

Right. When I'm buying a house in two years, I really want liquidity. I want access to these funds. And if I'm still working at that company with the 401k, I'm probably not going to be able to take out that money from the 401k to put a down payment on a house. So whether you're buying a car, a house, saving an emergency fund, make sure that you prioritize that flexibility for short and intermediate term savings.

and not just trying to push all your tax optimization into these long-term accounts. Yeah, totally agreed. I think having flexibility is absolutely essential. We've highlighted that on prior episodes. And yeah, I mean, like you've talked about this entire hour, the flexibility and all the benefits of a taxable brokerage account, it's just important that we all understand it. And frankly, like you said, this is seventh on your list, but realistically, you have workplace retirement accounts three times. And it's

Employee stock purchase plan is not applicable for a lot of people. HSA is not applicable for a lot of people. So realistically, yeah. If your question is, does this even matter for me? Well, yeah. I mean, listen, if you have a nice savings rate, is there a reasonable likelihood you're either going to max out your 401k or max it out to the point where you're comfortable? Yeah. Okay.

Okay. And then are you, maybe if you're eligible, are you going to max out a Roth IRA? Yeah, that's not that much money. Are you still going to have some leftover for savings? I think you will. And that's where this taxable brokerage account comes in. So I think for the vast majority, almost every single person in our community is going to have assets in a taxable brokerage account. So this is very important for you. Cody's just trying to set up how he thinks about his order of operations because it is important. And it's a question that people ask

quite, quite often. So yeah, Cody, I'm glad you went through it. Yeah, that's right. Now, Sean Mullaney and I were really, you know, we're big tax nerds. And he came up with this idea of what he calls the compelling three, which number one is your workplace retirement account. That's your 401k, 403b, 457. The second is your Roth IRA, which again has those contribution limits. And the third of the compelling three is the taxable account. So if you're able to max out a workplace retirement account, maybe an HSA, maybe a Roth IRA,

and you're able to contribute even more to a taxable account, you're probably really on the path to and through early retirement. So don't worry about trying to over-optimize. If you can put money into those compelling three, you're probably tracking to a great retirement moving forward. Wholeheartedly agreed. And Cody, so you mentioned Sean Mulaney. I know

you two are writing a book. I'm not sure what kind of, if we're in early stages, middle stages, where we are, any kind of sneak peek on that and when it might come out? Yeah. So today we talked about taxable brokerage accounts, which is one chapter out of 35 chapters that Sean and I have drafted, 80,000 words we've drafted so far. Wow. It's a pretty big book. We're hoping that it becomes like kind of, you know, one of the go-tos within the

Defy community. It's called Tax Planning to and Through Early Retirement. Maybe we can share a link in the show notes. If you want to sign up for an announcement, I'm not going to spam anybody with emails, but we're going to send out an email with an announcement date whenever that's... And we're kind of waiting to see what happens legislatively with Tax Cuts, Jobs Act, and other things. But we hope to release this book later this year. It's measuretwicemoney.com forward slash...

book, All Under Case. And that'll be a great place to just put in your name, email, no spam. We'll just let you know when it's coming. But we're really excited. Literally everything we know about tax optimized retirement planning, we're putting in that book. So we're excited to share with the community. Nice. That is wonderful. And as you guys know, from the number of times I've asked each of you back on the podcast, I...

treasure both of you and think you're just incredible, incredible humans and resources. So thank you guys. Thank you both. So I was going to ask where people should reach out to you. Measure twice money is your website, but yeah, go to measure twice money slash book, sign up for the announcement. And yeah, I can guarantee that's going to be a pretty phenomenal book.

We're going to make you write part of it, Brad. Maybe we'll have you write the foreword or something, right? That'd be fun. I'm in. I'm in. That sounds good. Awesome. Awesome. All right, my friend, as always, thank you for preparing this. This is wonderful. And until next time. All right. Take care, Brad. Thanks.

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