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Retirement Accounts vs Private Brokerage Accounts

In personal finance world there is a difference between your retirement accounts and your private brokerage accounts. The reason this distinction is made is to better account for taxes as well as create the optimum withdrawal strategy come retirement time.

For the early retiree it’s important to have both traditional retirement accounts to withdraw from after age 59.5 as well as have private brokerage accounts from which we can spend before age 60 without having to pay early withdrawal penalties.

 

Investment Timing

Early in our careers it’s best to maximize all retirement accounts in order to decrease our tax burden and use any extra money to pay down debt.

3-5 years after becoming an attending it should be feasible to be completely debt free. With retirement accounts maxed out, we can save up somewhere around $150,000-$300,000 in our 401k’s, 403b’s, 457, IRA’s, etc.

After maxing out these retirement accounts it’s important to focus on “taxable accounts” as well. Of course, all accounts are taxable but retirement accounts have a tax-deferred status – you pay taxes well into the future when you go to withdraw the money.

Your private brokerage accounts owe taxes whenever dividends are paid out and when you sell appreciated securities in such accounts. Don’t let anyone tell you this is a bad thing! When you’re paying taxes it’s because you’re making money – unless you have more money than you need, it’s always good to make money.

 

Money Sources For The Early Retiree

I see 4 main money sources for the early retiree:

  1. income from gigs/consulting/moonlighting
  2. cash savings
  3. private brokerage investment accounts
  4. retirement investment accounts

 

This post will mostly focus on the latter 2 because it’s not wise for the early retiree to only focus on their retirement accounts and neglect their private brokerage accounts.

 

Retirement Investment Accounts

If you have a 401k or 403b from your work then you have a retirement account. For the self-employed physician you might have an individual 401k (solo 401k) or a SEP IRA.

It’s up to you which particular investments you choose to hold in these investment vehicles. Quite a few of my colleagues just let the brokerage house decide for them while others are particular about which investments they want to hold.

Whatever you invest in, these accounts will grow year after year with your continued contributions, dividend income, and fund appreciation. You won’t pay any taxes on these gains until you go to withdraw money after age 60.

Accessing Retirement Accounts Early

Regardless of what everyone tells you, it’s easy to access your retirement funds even before the age of 59.5 – it’s just not simple.

There are a few calculations you have to do, some taxes to consider, or some penalties to pay but if it makes financially to do so, you can access your retirement accounts at any time.

A savvy financial adviser can help you plan this way ahead of time by using a ROTH ladder or help you figure out your SEPP withdrawal strategy.

 

Private Brokerage Investment Accounts

If your work offers you retirement accounts with Fidelity then you can also open a private brokerage account with them and buy private investment securities in such accounts.

Having everything under one roof will simplify your finances.

These accounts will be taxed whenever there is a taxable event. For this reason it’s beneficial to stay away from investments which have a lot of transactions or are tax inefficient.

Accessing Private Brokerage Accounts

What’s particular appealing about private brokerage accounts is the ease with which you can access them.

I have been tracking my dividend income from my investments the past year and instead of having them automatically reinvested, I have them deposited straight into a money market account.

This helps me keep track of that dividend income and I am free to spend it for my living expenses or do something else worthwhile with it.

But it’s not just dividends that allow me to profit from my retirement accounts. In the past 2 years my funds have appreciated by 10-20% a year.

$100k invested in my private brokerage accounts would allow me to have approximately 2% a year ($2,000) of dividend income and depending on the mood of the market, I might have another 2-6% ($2,000-$6,000) on average of investment profits from selling appreciated funds.

 

Limiting Contributions To Retirement Accounts

You will reach a point then it will make sense to stop contributing to retirement accounts and instead divert any extra savings towards a private brokerage account.

If you are still working and earning a high income then a retirement account might still be the right move. After all, your contributions will decrease your tax burden for that year.

However, if you are in the peri-retirement phase then you aren’t earning a whole lot – probably enough to have some elective spending and to cover your basic overhead.

In this phase it makes more sense to add money to your private brokerage accounts because these will be easier to access and withdraw from at a young age.

Speaking of easy access to your money, don’t forget about keeping a stash of cash. This would be separate from your Emergency Funds as I’ll explain below.

 

Keeping Money In Cash

The way our economy works, money loses value when it’s kept in cash. Though CD’s are finally starting to pick up some pace, the rate on return is still below that of inflation.

However, when you’re on the early retirement path it makes sense to keep some money on hand in cash. I don’t mean just physical dollar bills, it would be adequate to have the money in a savings account, money market account or a short-term CD.

The advantages to having easy access to some cash are:

  • flexibility in generating income streams
  • jump from gig to gig without having to worry about income
  • avoid dipping into your retirement accounts
  • avoid dipping into your private brokerage accounts
  • use your cash when your investments have lost value

 

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