Neglecting a Taxable Brokerage Account? Think Again.

Many federal employees who retire in their early to mid-50’s are sitting in a golden opportunity zone for tax planning. Roth conversions, selling appreciated real estate, tax loss/gain harvesting...these are all things to think about. The key to success is creating flexibility and options. Creating tax flexibility and different routes to success comes from tax diversification – having multiple “buckets” of money, each with different tax characteristics.

We spend a lot of time talking about tax-free and tax-deferred accounts, and for good reason. What you keep (after taxes) matters more than what you earn. This is why tax advantaged accounts like the Thrift Savings Plan (TSP), Individual Retirement Account (IRA), and Health Savings Account (HSA) are high up on my financial order of operations. However, there’s a type of account that doesn’t get as much “tax love”, but can still be a game changer. We’re talking about a plain vanilla taxable brokerage account. I’m going to use the abbreviation “TBA” to save us all some time.

7 Benefits

A TBA is an investment or savings account that isn't an IRA or an employer sponsored plan like the TSP or a private-sector 401(k). You can open a TBA at any of the major low-cost custodians, with a “robo-advisor”, or at your local bank. For easy access to a wide variety of inexpensive investments, I would consider a low-cost custodian like Vanguard, Fidelity, or Schwab. I personally have my TBA at Vanguard because that’s where my Roth IRA is held, and I want the fewest number of logins as possible.

(1) No Income Limits

With a TBA, your income has no effect on your ability to contribute. On the other hand, Roth IRAs have income limits which can prevent you from making a direct contribution (which is why we talk about “backdoor” Roth IRA conversions). With a traditional IRA, your ability to deduct contributions can be limited by your income and whether you and/or your spouse are covered by a workplace retirement plan.

(2) No Requirement for Earned Income

TBAs do not require earned income. This could become important during gap years, long periods of Leave Without Pay (LWOP), or investing during retirement when your sources of income aren’t technically “earned income”. With employer plans, you must have earned income to contribute. Once you separate from the federal government, you can no longer directly contribute to your TSP. You can do a transfer/rollover into the TSP, but that’s not the same as making new contributions. With IRAs, you (or your spouse) must have earned income to contribute.

(3) No Contribution Limits

You can invest as much money as you want in a TBA. In 2025, if you’re under age 50, you can contribute a maximum of $23,500 to your employer plan and $7,000 to an IRA. What if you’re a GS-15 living on rice and beans and have more than $30,500 to invest? What if you’re a Foreign Service Officer at a high-threat post with limited monthly expenses and surplus cash flow? The TBA could be the answer. For feds who are also military members, don’t forget, while serving in a tax-exempt qualified combat zone, you’re allowed to contribute more than the $23,500 “elective deferral” limit to your TSP. You may want to prioritize additional TSP funding before the TBA.

(4) Variety

With a TBA, you can invest in whatever you want. S&P 500, Total U.S. Stock Market, emerging markets, commodities, small cap value…you name it, you can find it. With the TSP we can invest in the 5 core funds, Lifecycle Funds, or the Mutual Fund Window. For 99.99% of federal employees, the core funds and Lifecycle Funds are great options and have made many people millionaires. I don’t love the Lifecycle Funds, primarily because they are misunderstood and used incorrectly. I shared four reasons why Lifecycle Funds may miss the mark here. I also don’t personally use the MFW because in my opinion, the fees are unreasonable and it’s not providing a tool that I need. Paying higher fees to try and solve a problem that doesn’t exist makes no sense to me. Please carefully weigh the pros and cons, and your reasoning, before using the MFW.

(5) No 10% Early-Withdrawal Penalty

Invest $1,000 in a TBA today at age 29 and then withdraw $1,000 next year at age 30, you’re good to go. The IRS doesn’t care how old you are or how long you kept the money invested. The tax rate you pay on profits can change depending on how long the investment was held, but there’s no 10% early-withdrawal penalty if you distribute money prior to age 59 ½ like there generally is with IRAs and employer plans.

Before you start drafting emails correcting this statement regarding age 59 ½, yes, there are plenty of exceptions to the 10% early-withdrawal penalty. Many federal employees can get access to their TSP earlier than age 59 ½.

Some Special Category Employees (SCE), who in the eyes of the IRS are also qualified public safety employees (QPSE), could theoretically get penalty-free access to their TSP in their 40’s (how: hired younger than age 24 + 25-years of service in that QPSE/SCE job). Other SCEs/QPSEs can start withdrawing at age 50 (how: age 50 + 20-years of service in that QPSE/SCE job). Click here to see if you are a QPSE. Finally, the non-QPSE/SCE crowd who separate from service in the year they turn 55 or later can enjoy TSP withdrawals without a 10% penalty. Note: The IRS says that you do not have to actually be 55 upon separation, you just have to turn 55 at some point in the year that you separate. For you QPSE/SCE folks, don’t forget the FERS/FSPS eligibility thresholds for an immediate unreduced annuity/pension, you must actually be age 50 (or have 25 years of SCE service) to qualify for your pension, not just turn 50 during the year of separation.

Two things to note with this “Rule of 55/50”: (1) These exceptions only apply to employer plans, not IRAs. If you transfer/rollover your TSP to an IRA, the age + service free pass from the 10% penalty goes away. (2) The exception only applies to the plan (TSP, 401(k), 403(b)) of the employer you are separating from. You cannot use the “Rule of 55/50” to get penalty-free access to an old 401(k) from a job in your 20’s. Solution: Roll the old 401(k) into the TSP if you want penalty free access.

(6) Step-Up in Cost Basis

What the heck does that mean? Think of “cost basis” as purchase price. When you die, your heirs can get a tax break with the TBA because the cost basis of the assets in the account can be adjusted to the fair market value on your date of death. Stick with me. Let’s say you bought ABC stock for $100 10-years ago. It grew in value to $500, and then you died. Your heirs will own the stock and have a “stepped-up cost basis” of $500. This just means it’ll be as if they bought it themselves for $500. So, if they sell it a year later for $550, they’ll only pay taxes on the $50 gain above their stepped-up cost basis, not the full $450 it grew since you first purchased it. Simply put, the difference between the cost basis and sale price is the profit that will be taxed. The higher the cost basis, the less profit to pay tax on. Stepping up that cost basis results in less taxable profit for your heirs.

(7) Taxes

When you contribute money to your TBA you don’t get a tax break, the money doesn’t grow tax-deferred, and you have to pay tax on interest, dividends, and capital gains (profits) the year you earn them. Wait a minute, this tax treatment doesn’t sound like a benefit. Let me explain.

With a TBA you have multiple opportunities to pay 0% tax on profits (more on this below). Even if you do have to pay tax on profits, the tax rate may be lower than your ordinary income tax rate. You can also hold tax-efficient investments that don’t force income each year. TBAs have no Required Minimum Distributions (RMDs) like IRAs and employer plans do once you reach a certain age (age 75 for those born in 1960 and later).

Capital Gains: If you buy a share of ABC stock for $100 and later sell it for $150, you’ve realized a $50 capital gain. If you held the share for one-year or less, that $50 will be taxed as a Short-Term Capital Gain (STCG), which means it’ll be taxed as ordinary income, just like your W2 income. If you held the share for more than one-year, the $50 will be taxed as a Long-Term Capital Gain (LTCG), which could be 0%, 15%, or 20% depending on your other income. High earners may also get hit with an additional 3.8% Net Investment Income Tax (NIIT) if your adjusted gross income exceeds $200,000 (single) or $250,000 (married filing joint).

Note: Don’t apply this capital gains information to your TSP or IRA – it’s not the same. You don’t pay capital gains tax on profits in your TSP or IRA. Instead, you’ll pay ordinary income on traditional (pre-tax) dollars when they are distributed/withdrawn from the account. Qualified distributions of Roth (post-tax) dollars are tax-free when distributed/withdrawn. Rebalancing or reallocating (buying and selling funds within the TSP or IRA) are not taxable events.

If the investments held in the TBA are paying interest and/or dividends, you’ll have to pay taxes on those in the year they are paid (even if the dividends are reinvested). It doesn’t matter if you sell the asset or not; if income is produced within the TBA, you’ll receive a 1099 tax form reporting the income that year.

When you get the 1099, you’ll see that some dividends are categorized as “qualified”, while others are categorized as “ordinary”. Qualified dividends are the ones we like, because they receive more favorable tax treatment. Generally speaking, qualified dividends are payouts from U.S. companies or foreign companies that trade on one of the major U.S. stock exchanges. You also have to satisfy a holding period requirement to get the qualified treatment. Qualified dividends receive the more favorable LTCG tax treatment. Ordinary dividends on the other hand are going to be taxed at the same rate as your ordinary income (the same tax rate that applies to your W2 income and Short-Term Capital Gains).

Tax Gain & Tax Loss Harvesting

There are opportunities when selling your investments in a TBA at a loss or a gain that could be beneficial to your overall tax picture. This has to do with using capital losses to off-set capital gains and up to $3,000 worth of ordinary income. There’s also the ability to realize a gain, pay little or no capital gains tax, and immediately repurchase the asset to reset your cost basis/purchase price. More on tax loss and gain harvesting here.

Warning

Everything in this article has focused on federal taxes. When tax gain harvesting or implementing other strategies with the TBA, you may still owe state tax on your gains. Also, increasing your income could cause other tax dominoes to fall such as how much Social Security income is taxable, the application of the Net Investment Income Tax (NIIT), your eligibility for Premium Tax Credits (ACA healthcare), the Medicare Part B surcharge (IRMAA), student aid eligibility, and other deductions and credits.

Rebalancing

Be cautious when using your TBA to rebalance your portfolio. If you have a target allocation of 90% stocks and 10% bonds, and stocks happen to perform well one year, your allocation may have drifted up to 95% stocks. In a simple scenario, you’d want to sell some stocks and buy some bonds to get back to your target 90/10 split. If possible, avoid selling stocks to rebalance within the TBA because that would create a taxable event. Instead, you’d want to rebalance within your tax-advantaged accounts (e.g., IRA, TSP, & HSA).

Which Investments for a TBA

Knowing that you’ll have to pay tax on interest, dividends, and capital gains each year, you should try and avoid putting high interest/dividend paying assets in the TBA. Turnover is another thing to lookout for. Turnover, a hallmark of actively managed funds, is buying and selling that takes place within a fund (outside your control). Each time a fund manager sells assets within a fund, it can generate capital gains. Consider holding low-cost, broadly diversified, passively managed index funds that aren’t expected to produce large capital gains distributions.

Final Thoughts

While TBAs don’t get as much attention as other accounts, they offer a lot of benefits. Having a TBA bucket alongside your TSP and IRA could create multiple levers to pull, reducing your overall lifetime tax burden. I would still consider TBAs quasi tax-advantaged accounts since they offer the opportunity to pay LTCG versus ordinary income tax. These accounts can have significant impact and create tax flexibility for feds who are still working, nearing, or already in retirement. If you’ve hit the maximum contribution limits within your TSP and IRA, and an HSA isn’t aligned with your health/medical situation, a TBA makes a lot of sense for additional investing.

About the Author

Tyler Weerden is a fee-only financial planner and the owner of Layered Financial, a Registered Investment Advisory firm based in Arlington, Virginia. In addition to being a financial planner, Tyler is a full-time federal agent. He holds a Bachelor of Science degree, a Master of Science degree, passed the Series 65 exam, and is a Certified Fraud Examiner (CFE). Tyler is the sole Investment Adviser Representative at Layered Financial.

Prior to becoming a federal agent, Tyler served as a state trooper, local police officer, and was a member of the U.S. Army National Guard. He has served in both domestic and overseas Foreign Service assignments. Tyler has experience with local, state, and federal pension systems, 457(b) Deferred Compensation, the federal Thrift Savings Plan (TSP), Individual Retirement Accounts (IRAs), Health Savings Accounts (HSAs), and various investment options to include rental real estate.

Disclaimer

Layered Financial is a Registered Investment Adviser registered with the Commonwealth of Virginia and State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Nothing in this article should be seen as a recommendation or advertisement. Layered Financial and its Investment Advisor Representatives have no third-party affiliations and do not receive any commissions, fees, direct compensation, indirect compensation, or any benefit from any outside individuals or companies. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments, types of investments, products, or companies are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment, solicit the business, or use that product. The author of this publication may hold positions in investments or types of investments mentioned in articles. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.

© 2025 Tyler Weerden. All rights reserved. This article may not be reproduced without express written consent from Tyler Weerden.