Taxable vs. Tax-Advantaged Accounts

Dear DTA, 

I’m not sure which accounts I should be using when I invest. What’s the difference between an IRA and a 401(k)? Can I access my savings before I’m 70? Thanks!

-Patti D. 

Hi, Patti.

Thanks for writing in. It’s always such a pleasure to hear from our readership.

You’ve got a great question there.

There are so many different accounts out there. I understand that it can be confusing to the uninitiated.

However, I can assure you that it’ll all make much more sense once you take the time to educate yourself on the various options.

First, I would think of the different accounts in a way that separates them into two different buckets.

Those buckets are: taxable accounts and tax-advantaged accounts.

The former would be an account where post-tax income goes into an account and that account is “regular” in the way its investments are taxed. There are no advantages or deferments here in terms of tax, but the account is extremely flexible, liquid, and accessible.

The latter would be an account where, typically, pre-tax income goes into an account and that account is “advantaged” in the way its investments are taxed. Tax is usually deferred in some way, but the account is usually inflexible, less liquid, and not nearly as accessible.

A regular brokerage account would be a taxable account.

A 401(k) or an IRA would be a tax-advantaged account.

What’s really important here, Patti, is that you take the time to think very hard about your overall financial goals.

Questions you’ll want to ask yourself include:

When do you want to retire? 

How much money can you save per year? 

How much money do you plan on spending in retirement? 

Does your job offer a 401(k) match? 

That’s not an exhaustive list by any stretch. But it’s a good start.

I can tell you that tax-advantaged accounts are best for those who plan on a more traditional career arc.

For example, if you plan on having a job of some kind until you’re in your 60s, tax-advantaged accounts, especially a 401(k) with an employer match, would be instrumental.

But if you have any designs on having freedom much earlier in life, you’ll want to be very careful about how you approach this.

Personally, I never wanted to have a traditional career arc. Autonomy is priceless to me.

That’s why I quit my job in my early 30s.

By living below my means and intelligently investing my capital, I was able to become financially independent and retire at only 33 years old.

I lay out the specifics of that journey in my Early Retirement Blueprint.

Now, I never used tax-advantaged accounts.

That’s because I knew all along that I wanted maximum financial flexibility. I had to make sure I could access my investments at a very young age.

I instead used taxable accounts to build my FIRE Fund.

That’s my real-money early retirement stock portfolio.

And it generates the five-figure passive dividend income I live off of.

Jason Fieber's Dividend Growth PortfolioIf I would have instead went crazy with the tax-advantaged accounts, I wouldn’t have been able to quit my job at such an early age.

That’s because those accounts make it very difficult to access your wealth and passive income before the proper age, without penalty (at least 59.5 years old in most cases).

Regardless of what career and life arc you have in mind for yourself, Patti, the investment strategy that I used to get to where I’m at is a strategy that can be used by anyone.

That includes those who plan to use tax-advantaged accounts and have a job until they’re 60 or older.

The strategy I used to retire at such a young age is dividend growth investing.

It’s an amazing strategy for building significant wealth and passive income.

It advocates buying and holding shares in world-class enterprises that pay reliable and rising dividends.

You can see what I mean by perusing the Dividend Champions, Contenders, and Challengers list.

That list has compiled invaluable data on more than 800 US-listed stocks that have raised dividends each year for at least the last five consecutive years.

There are household names all over that list.

This shouldn’t be a surprise.

After all, it takes a phenomenal business to be able to pay out growing cash dividends to shareholders for years on end. You practically cannot run a poor business while simultaneously writing ever-larger checks. That math doesn’t work for very long.

Since I knew I was quitting the security of a job at such a young age, I knew I had to tie my fate and fortunes to the best businesses in the world.

And that’s why I’m a dividend growth investor.

One great thing about this strategy is, it’s not difficult to learn and take advantage of.

Fellow contributor Dave Van Knapp puts the strategy in layman’s terms with his Dividend Growth Investing Lessons.

He goes through all you need to know to successfully execute this strategy and use it to build wealth and passive income fairly quickly.

If you decide to use this strategy, regardless of the type of accounts you choose, make sure to follow my Undervalued Dividend Growth Stock of the Week series.

Every Sunday, I highlight a compelling long-term dividend growth stock investment idea.

Undervalued Dividend Growth Stock of the Week by Jason FieberThe stocks are filtered from the aforementioned CCC list, after which they undergo a rigorous analysis and valuation.

Only the best ideas are put forth for the community.

You have some important decisions to make, Patti.

Either way, you’re in for an exciting ride ahead.

Becoming part of the investment class is something almost any American can do.

And it can radically change your life for the better.

No matter which accounts and strategies you settle on, Patti, I’ll leave you with my best advice of all.

Start today. 

I wish you luck and success.

Jason Fieber

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Disclaimer: Jason Fieber is not a licensed financial advisor, tax professional, or stock broker. Please consult with a licensed investment professional before investing any of your money. If your money is not FDIC insured, it may decline in value. To protect the privacy of our readers, any names published in this article are under aliases. In addition, text may be edited, omitted or paraphrased for grammar or length.