Roth IRA vs taxable brokerage: when tax-free growth beats step-up basis
The Roth IRA is tax-free in retirement but is locked until 59.5 (mostly) and is capped at $7,000 per year. The taxable brokerage is taxable on dividends and capital gains but is unrestricted in size, in age of withdrawal, and benefits from step-up basis at death. The Roth wins for retirement dollars; the taxable brokerage wins for pre-59.5 access and intergenerational wealth. Most serious savers should use both, in that order.
The arithmetic over 30 years
Compare $7,000 invested in a Roth IRA versus the same $7,000 invested in a taxable brokerage account. Assume 7% nominal annual returns (5% from price appreciation, 2% from qualified dividends). Hold for 30 years. Withdraw at the end.
Roth IRA. $7,000 grows at 7% compounded for 30 years to $53,300. Withdraw the entire amount tax-free at age 65+. After-tax proceeds: $53,300.
Taxable brokerage. The 2% qualified dividends are taxed each year. For a saver in the 22% bracket during accumulation, the qualified dividend rate is 15%, so $7,000 × 2% × (1 - 0.15) = $119 of after-tax dividend reinvestment in year one. The effective after-tax return is approximately 7% × (1 - 0.15 × 2/7) ≈ 6.70%. Over 30 years, $7,000 grows to approximately $49,200 of pre-liquidation balance. The accumulated capital gain is approximately $42,200. At a 15% long-term cap gains rate in retirement, the tax on liquidation is approximately $6,330. After-tax proceeds: $42,870.
Difference: Roth wins by about $10,400 per $7,000 contribution over 30 years, or roughly 24%. The advantage grows with longer holding periods and higher gross returns.
However, this comparison assumes the taxable brokerage is liquidated. If instead the taxable brokerage is held until death and bequeathed, step-up basis under IRC §1014 eliminates the capital gain entirely. The heir inherits $49,200 with a fresh basis of $49,200. The pre-tax compounding effectively becomes tax-free at the inheritance point. The taxable brokerage matches the Roth on this scenario, though the intermediate dividend taxation still leaves a small Roth advantage.
The 2026 capital gains structure
Long-term capital gains (assets held more than one year) are taxed under IRC §1(h) at 0%, 15%, or 20% depending on taxable income. The 2026 brackets per IRS Notice 2024-80:
- 0% LTCG: single taxable income up to $48,350 / MFJ up to $96,700
- 15% LTCG: up to $533,400 single / $600,050 MFJ
- 20% LTCG: above the 15% caps
Qualified dividends use the same brackets. Non-qualified dividends and short-term capital gains (assets held one year or less) are taxed at ordinary income rates.
For a retired couple with modest ordinary income, the 0% LTCG bracket is a powerful planning tool. A couple at $80K of MFJ ordinary income (already covering Social Security and pension) with $96,700 of taxable income headroom in the 0% LTCG bracket can realise up to $16,700 of long-term capital gains at 0% federal tax. State taxes still apply in most states, but the federal portion is zero.
This is the "tax gain harvesting" strategy: deliberately realise capital gains in years when you're in the 0% LTCG bracket, to reset your basis higher without paying federal tax. The taxable brokerage account specifically benefits from this; the IRA accounts do not (IRA withdrawals are always ordinary income, no LTCG treatment regardless of holding period).
The Net Investment Income Tax (NIIT) under IRC §1411 adds 3.8% to capital gains and dividends for filers with MAGI above $200K single or $250K MFJ. This applies to taxable brokerage holdings, not to IRA distributions. For high earners, the effective combined rate on long-term capital gains can reach 23.8% federal (20% LTCG + 3.8% NIIT) plus state.
Tax-loss harvesting in the taxable account
Capital losses in a taxable brokerage can offset capital gains, dollar-for-dollar. Up to $3,000 of net capital loss can offset ordinary income in any year (IRC §1211). Unused losses carry forward indefinitely (IRC §1212(b)).
The mechanics. In a down market, sell positions trading at a loss. Use the loss to offset gains realised elsewhere (rebalancing trades, mutual fund cap gains distributions). If losses exceed gains, deduct $3,000 against ordinary income at your marginal bracket. For a 32% federal + 5% state bracket saver, that's $1,110 of annual tax savings from one $3,000 loss.
The wash-sale rule under IRC §1091 prevents tax-loss harvesting if you repurchase substantially identical securities within 30 days (before or after the sale). The standard workaround: sell Vanguard Total Stock Market (VTSAX) at a loss, immediately buy a similar-but-not-identical fund like Vanguard Large-Cap Index (VLCAX) or Schwab Total Stock Market (SWTSX). 31 days later, you can swap back if you prefer. The IRS has not formally defined "substantially identical" for index funds, but the widely-accepted convention is that different fund families or different specific indices are not substantially identical.
Tax-loss harvesting works only in taxable accounts. Losses inside an IRA cannot be harvested for any tax purpose. This is one of the structural advantages of taxable brokerage for sophisticated investors: ongoing tax-loss harvesting can add 50-100 basis points of after-tax return per year, especially in volatile markets.
Step-up basis at death
IRC §1014 provides that inherited assets receive a basis "stepped up" to the fair market value on the date of the original owner's death (or the alternate valuation date six months later if elected). Decades of accumulated capital gain disappear at the moment of death. Heirs can sell the assets immediately after inheritance with zero capital gains tax.
Example. You bought $10,000 of an S&P 500 ETF in 1995. Today it's worth $90,000. If you sold it during your lifetime, you would owe LTCG tax on the $80,000 of gain. If you bequeath it and die today, your heirs inherit it with a basis of $90,000. They can immediately sell for $90,000 and owe zero capital gains tax. The $80,000 embedded gain disappears.
The step-up does not apply to Roth IRAs or Traditional IRAs. IRA balances are distributed to beneficiaries under the inherited-IRA rules (10-year rule for most non-spouse beneficiaries since SECURE Act 2019 §401). Roth IRA inheritances are distributed tax-free (with the 5-year rule applying to earnings). Traditional IRA inheritances are taxed as ordinary income to the beneficiary. Neither gets a basis reset.
For someone planning to leave money to heirs, the comparison shifts. A taxable brokerage account that benefits from step-up at death effectively converts ordinary capital-gains-tax exposure into tax-free intergenerational transfer. For an estate plan that prioritises bequest, the taxable brokerage can be a more tax-efficient vehicle than a Roth IRA, despite the Roth's in-lifetime tax-free treatment.
The most tax-efficient estate-planning arrangement for many large estates: bequeath Roth IRA to charity (charity doesn't care about the tax treatment because they pay no tax anyway), bequeath taxable brokerage to individuals (who benefit from step-up basis), and use Traditional IRA balances during your lifetime to fund spending (the ordinary-income-tax cost falls on you at your bracket, not on heirs at their bracket).
The decision rule
Roth IRA wins for retirement-target dollars accessible after 59.5.The tax-free growth and tax-free withdrawal beat the taxable brokerage's 15-20% LTCG hit, especially over multi-decade horizons. Max the Roth IRA (or backdoor Roth) before putting dollars into taxable.
Taxable brokerage wins for pre-59.5 access dollars. Withdrawal is unrestricted at any age. Capital gains tax on liquidation is typically lower than what would be ordinary income on early IRA withdrawal plus the 10% penalty. The taxable brokerage is the standard FIRE bridge account before age 59.5 (or before the Roth conversion ladder rungs mature).
Taxable brokerage can win for bequest dollars. Step-up basis at death makes accumulated capital gain disappear. For a saver with substantial estate who plans to bequeath rather than spend, the taxable brokerage matches or beats the Roth IRA on an after-tax intergenerational basis.
The pragmatic priority for most savers: max all tax-advantaged accounts first (401(k) match, HSA, Roth IRA, max 401(k), Mega Backdoor if available), then taxable brokerage for everything above. This ordering produces both the Roth tax-free retirement pool and the taxable brokerage flexibility / bequest engine, instead of choosing between them.
FAQ
Is the Roth IRA always better than a taxable brokerage?
For pure retirement-target dollars used after 59.5, almost always yes. For pre-59.5 access dollars, taxable brokerage wins. For dollars you might bequeath rather than spend, step-up basis can make taxable brokerage match or beat Roth IRA on an after-tax basis.
What is the 0% long-term capital gains bracket?
Single filers with taxable income up to $48,350 (2026), MFJ up to $96,700. Within this bracket, qualified dividends and long-term capital gains are taxed at 0% federally. State tax may still apply.
What is the wash-sale rule?
IRC §1091 disallows the loss on a security if you buy a substantially identical security within 30 days before or after the loss sale. The standard workaround is buying a similar-but-not-identical fund (different index, different provider) and waiting 31+ days to swap back.
What is step-up basis?
IRC §1014 sets the cost basis of inherited assets to the fair market value at the original owner's date of death. Decades of accumulated capital gain disappear at death. Heirs inherit with a fresh basis and owe no capital gains tax on the appreciation during the deceased's lifetime. Applies to taxable brokerage, not to IRAs.
Should I tax-loss harvest in my Roth IRA?
Cannot. Losses inside a Roth IRA (or any retirement account) cannot be harvested for tax purposes. Tax-loss harvesting is exclusively a taxable-account technique.
Is the Net Investment Income Tax relevant?
Yes, for high earners. NIIT under IRC §1411 adds 3.8% to capital gains and dividends for filers with MAGI above $200K single or $250K MFJ. Applies to taxable brokerage holdings, not to IRA distributions. For high earners the effective combined rate on LTCG can reach 23.8% federal.
Not financial, tax, or legal advice. Figures sourced from IRC §1(h) (capital gains rates), IRC §1014 (step-up basis), IRC §1091 (wash-sale rule), IRC §1211 (capital loss limitation), IRC §1212(b) (capital loss carryforward), IRC §1411 (Net Investment Income Tax), IRS Publication 550 (Investment Income and Expenses), IRS Notice 2024-80 (2026 LTCG brackets). Tax laws change. Consult a fiduciary financial advisor, CPA, or qualified retirement planner.