Personal Finance

Is it better have $3 million in a taxable brokerage or in a 401(k) - which would you pick?

Rich Duprey

Published: December 11, 2024 7:20 am

Receiving a large windfall allows you to make a lot of choices about your finances and your retirement that were previously closed off. Money is not the be all, end all it’s made out to be, but it’s not a bad problem to have.

Where to keep that money is another issue. A Redditor on the r/ChubbyFIRE subreddit asked whether it was better to keep an after-tax $3 million windfall in a taxable account, since the taxes have already been paid, or put it into a pre-tax 401(k), especially when you’re not near your early retirement date.

While the immediate reaction might be the 401(k) option, as that is the default of many people working towards a comfortable living after retiring early, it’s not necessarily the case when you’re suddenly gifted with a massive windfall.

Although I’m not a financial planner or tax professional, so these are just my opinions, let’s look at some of the reasons why a taxable account might be the preferred option, especially if you’re not close to retirement.

24/7 Wall St. Key Points:

• A windfall of any size is a blessing, but especially so when you can pocket $3 million after taxes.
• Where to park that money raises all kinds of questions over which is better, particularly for tax liability and accessibility.
• Many may be surprised by just how useful putting the windfall into a taxable account can be.
• But don’t dismiss a 401(k) retirement plan either as it still has important strategic considerations in this instance.
• Also: Take this quiz to see if you’re on track to retire ^(Sponsored)

Arguments in favor of a taxable account

Funds available for immediate use. We often solely focus on the retirement aspects of saving money, and rightly so, but putting the $3 million in a taxable account makes that money immediately accessible for any purpose. While you certainly can (and arguably should) invest it for retirement, you might need or want to spend it elsewhere, such as using it for a down payment on a house. The flexibility a taxable account offers is invaluable, especially for younger individuals.

Controlling the tax bite. You have more control over your tax burden with the taxable account because you can strategically time your withdrawals to minimize your tax liability. For example, you could choose to withdraw less in years with lower income and more in years with higher income.

Greater investment options. Flexibility over investments is greater in a taxable account as well. There is a wider range of assets to choose from, including those not typically available in retirement accounts, such as real estate, private equity, or alternative assets.

Greater tax efficiency. Since you paid taxes upfront on the $3 million, you can invest and grow this money tax-free until you withdraw it. That tax-free growth allows for more powerful compounding, leading to potentially larger gains over time. It also allows for tax-loss harvesting, where you sell losing investments to offset capital gains from other winning investments, potentially reducing your overall tax liability.

Better retirement planning. While the 401(k) is great for retirement savings, the $3 million in a taxable account could be used to build a separate portfolio for your retirement. This allows you to diversify your investments and potentially grow your wealth more quickly.

The case for a 401(k)

Although the taxable account arguments are compelling, don’t dismiss the 401(k) option out of hand. It has some benefits as well.

Tax deferred growth. If you don’t need the money right away, stashing the cash in a 401(k) account could be the right choice, particularly for high wage earners, because of the tax-deferred growth, again offering greater compounding opportunities over time.

Strategic conversions to minimize taxes. Having the windfall in a pre-tax account gives you more options when it comes to withdrawals later. As you approach retirement, you can start a Roth ladder strategy to convert your pre-tax account to a Roth so you can withdraw from the Roth penalty-free before retirement age. This is especially useful for people looking to retire early who need a way to access their 401(k) funds. You might just end up paying less tax, too.

Protection from creditors. Money in a 401(k) is generally protected from creditors in the event of bankruptcy, providing an additional layer of security for your retirement savings.

Key takeaway

While putting a windfall into a taxable account might seem counterintuitive, there are some very good reasons you might want to choose that option. Don’t dismiss putting the funds into a 401(k), as that offers advantages too. It’s why consulting with financial planners and tax professionals is essential.