For those planning to retire early, traditional retirement accounts such as 401(k)s and IRAs, while tax-advantaged, present some limitations. This is where taxable brokerage accounts become a powerful and flexible financial tool. They offer early retirees strategic advantages, including liquidity, control over taxable income, and the ability to fund essential expenses like healthcare and lifestyle needs, all while supporting long-term tax planning, such as Roth conversions.
Here’s a closer look at why brokerage account assets are valuable for early retirees:
1. No Age Restrictions on Withdrawals
One of the primary benefits of brokerage accounts is accessibility. Unlike traditional retirement accounts that penalize withdrawals before age 59½ (with a few exceptions), brokerage account assets can be accessed at any time without tax penalties. This makes them ideal for bridging the gap between early retirement and the age at which other retirement assets become available.
2. Flexibility to Manage Taxable Income
Brokerage accounts are taxable, but they offer tax flexibility: You can control when you realize capital gains and any long-term capital gains that are realized are taxed at favorable rates (0%, 15%, or 20% depending on income). Additionally, all qualified dividends are also taxed at these long-term capital gains rates. By strategically managing withdrawals and sales, retirees can keep taxable income low, sometimes even qualifying for 0% capital gains tax if income is below certain thresholds.
3. Facilitating Roth Conversions
One of the most powerful tax planning tools in early retirement is the Roth conversion. This strategy consists of moving money from a traditional IRA to a Roth IRA. This creates taxable income in the year of the conversion, but once in the Roth, the money grows tax-free and can be withdrawn tax-free in retirement. Brokerage accounts support Roth conversions in several ways. They provide cash flow to cover taxes from the conversion, allowing you to convert aggressively without dipping into the retirement accounts themselves.
Additionally, with lower taxable income in early retirement (no wages), you may be in a lower tax bracket than when you were working. Roth conversions will allow you to pay taxes now while you are in the lower tax bracket, allowing you to avoid higher tax rates later on. Additionally, strategic conversions over several years can help reduce future Required Minimum Distributions (RMDs) and lower lifetime taxes.
4. Paying for Health Insurance Before Medicare
Healthcare is one of the biggest expenses for early retirees who are too young to qualify for Medicare (age 65). Brokerage assets provide a source of liquidity to pay for health insurance premiums such as ACA Marketplace premiums, COBRA premiums, and direct payments for private insurance. Due to ACA premium subsidies being income-based, retirees with brokerage accounts can better control their Modified Adjusted Gross Income (MAGI) by choosing how much (and when) to realize income. This can lead to significant savings on health insurance via premium tax credits.
5. Supplementing Lifestyle Needs While Delaying Social Security
Delaying Social Security until age 70 maximizes monthly benefits. Brokerage accounts can help fill the gap in income during the waiting period, giving early retirees the option to delay claiming benefits without sacrificing lifestyle. This strategy, combined with Roth conversions and low-income years, can dramatically improve long-term retirement outcomes.
While traditional retirement accounts offer tax-deferred growth and Roth IRAs provide tax-free withdrawals, taxable brokerage accounts are the unsung heroes of early retirement planning. They deliver unmatched accessibility, flexibility, and strategic tax advantages, allowing early retirees to manage income, control taxes, and fund life goals long before age 59½. For those aiming to retire early, building a healthy balance in a brokerage account, alongside tax-advantaged retirement accounts, is essential for a well-rounded, sustainable financial strategy.