You’re not the only one who has ever been told to “max out your 401(k)” and felt a little unsure. In a lot of cases, the advice is good, but things have changed. We’ll show you with clear examples and plain language whether a taxable account can beat a 401k in this article. You can then choose which one works best for you and your goals.
whether you should have a taxable account or a 401k depends.
There isn’t a single answer. A 401(k) is often the better choice, especially if it has a good employer match and low fees. In some cases, though, a taxable account can be better than a weak 401(k). Before you decide to put extra savings into a brokerage account, here are the most important things to think about.
Why a 401(k) is often the best option
Employer match: It’s hard to beat free money. If your employer offers a match, make sure to give at least enough to get the full match first.
Tax-free growth or tax-deferral: Traditional 401(k)s let you make contributions before taxes and grow your money without paying taxes. Roth options let you take money out without paying taxes.
Automatic investing: Deductions from your paycheck make it easier to stay invested over time.
401(k)s are designed for retirement savings and have rules like contribution limits and qualified distribution rules that help people stick to their plans over time.
When a taxable account is better than a 401k
Tax-sheltered plans are great, but a taxable account can be better in these situations:
Your 401(k) costs a lot. Returns can be eaten up by high administrative fees or bad investment choices.
No or very little employer match. The 401(k) incentive isn’t as strong if your employer doesn’t match.
You need money or freedom. Taxable accounts let you take money out without paying a penalty and give you more options for how to do it.
You think that taxes will go up when you retire. When you have taxable accounts, you can realize capital gains whenever you want and take advantage of long-term capital gains rates.
You should put your money into tax-efficient investments like low-cost ETFs or municipal bonds that don’t pay out a lot of taxes.
How to compare: facts and a simple list
To begin, look at the net returns after taxes and costs. Find out how much the 401(k) costs in terms of plan fees and expense ratios. What percentage of my salary does my employer match? How much control do I want over when I invest and when I take money out? If you’re trying to decide between a taxable account and a 401k, do some quick math: figure out what the average long-term returns are, what the likely fees are, and what the likely taxes will be in the future. Over time, small differences add up to big results.
Tax rules that change the numbers
Taxable accounts are taxed in a different way than regular 401(k)s. When you have a taxable account, you have to pay taxes on dividends and realized capital gains. Long-term capital gains rates are usually lower than regular income rates. You can deduct your contributions to a traditional 401(k) from your taxes right away, but you have to pay regular income tax on any money you take out. With Roth accounts, you pay taxes now and then your money grows and you can take it out without paying taxes. So, if you think you’ll be in a higher tax bracket when you retire, it might be good to have more money in taxable accounts (or Roth vehicles). These tax expectations play a big role in the choice between a taxable account and a 401k.
Tax efficiency and investment options
If you want to include a taxable account in your plan, be careful about what you put in it. Tax-efficient investments, like broad-market index ETFs, tax-managed funds, and municipal bonds (for taxable income), lower the amount of taxes you have to pay. If you don’t want to pay taxes on the money, stay away from assets that make big annual nonqualified distributions in a taxable account. If you own mutual funds that churn and pay out capital gains, those can cause taxable events that make a brokerage account less useful.
A step-by-step approach is a practical way to go.
Get the match. Always take advantage of the employer match in a 401(k).
Next, max out your IRAs. If you qualify, put money into a Roth or traditional IRA. These plans often have better low-cost options than workplace plans.
Check the quality of the 401(k). If your 401(k) has high fees or not many good options, put money into the IRA first. Then, think about whether you should put more money into the 401(k) or a taxable account.
Taxable accounts give you more options. If you’ve reached the maximum amount you can put into your retirement account or you need to save for something before you retire (like a house, school, or early retirement), a taxable account is a good option.
Think about tax-loss harvesting and where your assets are. Keep assets that don’t help you pay taxes in the tax-advantaged plan and assets that do help you pay taxes in the taxable account. Use losses to make up for gains when you can.
Real-life examples that make the choice clear
- Example A: A good 401(k) with a match and low fees. The best thing to do is to max out the match and think about making more contributions to your retirement account. Start with your 401(k), then your IRA, and finally your taxable account.
- Example B: A bad 401(k) with bad fund options and no match. Put your money into an IRA (or a backdoor Roth if you need one) and then into a taxable account. Only put money into your 401(k) if you still need tax-deferred space.
- Example C: Someone who is retiring early or who thinks their taxes will go up later. A combination of taxable assets and Roth conversions could give you more options for managing your taxable income in retirement.
Behavioral and lifestyle factors
Don’t ignore behavior. A lot of people do best when their investments are automatic and out of sight. A 401(k) makes saving easier. That behavioral advantage is important if having a taxable account makes you more likely to save because it feels flexible and motivating. On the other hand, if you tend to use taxable savings for things that aren’t necessary, tax-advantaged accounts can help keep your retirement savings safe.
In the end, the smart balance is between a taxable account and a 401k.
In some situations, a taxable account can be better than a 401k. These include when the plan is bad, there is no match, you need money quickly, or you expect taxes to be lower on capital gains. But in most normal situations, especially when there is an employer match and the fees are reasonable, the 401(k) is still a very useful tool. For many savers, the best thing to do is to get the employer match, use IRAs for choice and tax flexibility, and then use taxable accounts to save more money and reach their life goals.
Disclaimer: This article provides general information and should not be taken as personalized financial advice. Tax rules are complex and change frequently; consult a qualified financial planner or tax professional who can consider your full financial picture before making major decisions.
