In 1999, tech investor Peter Thiel put less than $2,000 into a Roth IRA. Fast forward ~20 years, and that Roth IRA ballooned to $5 billion (yes, with a “b”) tax-free. How? Thiel used his Roth IRA to buy dirt-cheap startup shares (think early Facebook), and all the growth happened inside the Roth wrapper. Because Roth IRAs are funded with after-tax dollars and all future gains are tax-exempt, Thiel can withdraw those billions in his late 50s without owing a single penny to the IRS.
Now, most aren’t ultra-wealthy VC investors, and I’m definitely not promising you a billion-dollar IRA (SEC would have my head!). But Thiel’s case is an extreme example of a powerful truth: which account you use to hold an investment can make a huge difference in taxes and growth.
Understanding Your Investment Account Options
Traditional IRAs, Roth IRAs, 401(k)s, and Brokerage Accounts are the main tools in our toolbox. They each have unique rules on contributions, taxes, and withdrawals. Here’s a quick comparison from my front-row seat as a financial advisor:
Traditional 401(k) – usually offered by your employer. You contribute pre-tax money (lowers your taxable income today), and it grows tax-deferred. Withdrawals in retirement are taxed as regular income. Annual contribution limits are high (up to $23,500 in 2025). For 2025, the catch-up contribution limit for those aged 50 to 59 and 64 or older is $7,500. Additionally, starting in 2025, individuals aged 60 to 63 can contribute up to $11,250 as a catch-up contribution if the plan allows.
Many employers even match contributions (free money alert!). However, there are strings attached: take money out before age 59½ and you’ll generally pay a 10% penalty plus taxes, and Uncle Sam forces you to start withdrawing at age 73 (required minimum distributions, or RMDs).
Traditional IRA – an Individual Retirement Account you open yourself. Works like a mini-401(k): contributions may be tax-deductible (pre-tax) depending on your income and if you have a workplace plan. It also grows tax-deferred, and withdrawals are taxed as ordinary income. The trade-off is a lower contribution limit (capped at $7,000 per year in 2025 if under 50, with an additional $1,000 catch-up contribution for those 50 and older). Like the 401(k), withdrawals before 59½ typically incur a 10% penalty and RMDs kick in at 73..
Roth IRA – the Roth is like the cool cousin of the Traditional IRA. You contribute after-tax money (no upfront tax break), but in exchange, all growth is tax-free, and qualified withdrawals in retirement are tax-free. Put simply: pay taxes on the seed, not on the harvest. Roth IRAs have the same annual contribution limit as IRAs, but income limits apply – high earners (income ≈ $150k+ single or $236k+ married in 2025) can’t contribute directly. Key word here: directly.
There are no RMDs for Roth IRAs in your lifetime (you can let it grow tax-free as long as you want). Early withdrawals of contributions are penalty-free (since you already paid tax) – a nice emergency valve – but touching the earnings before 59½ could trigger tax/penalty. Many employers now offer Roth 401(k)s as well, which have no income limit and higher contribution space, combining Roth tax treatment with 401(k) convenience.
Backdoor Roth IRA – This option is particularly appealing if you’re a higher earner who’s frustrated by income limits preventing direct Roth IRA contributions. You begin by making a non-deductible contribution to a Traditional IRA (no upfront tax break), and shortly thereafter, you convert it to a Roth IRA. Since your original contribution was after-tax, the conversion itself isn’t taxable—allowing you to enjoy the Roth’s tax-free growth despite technically earning too much. But—yes, there’s always a “but”—the IRS throws in a tricky “pro-rata” rule. If you already have existing Traditional IRAs with pre-tax dollars, your backdoor strategy might inadvertently trigger a tax bill on part of your conversion. If you’re considering this strategy, talk to your financial advisor first (that could be me!) to ensure it’s done properly and tax-efficiently.
SEP IRA – SEP IRAs (Simplified Employee Pension IRAs) are particularly attractive if you’re self-employed or run a small business. Think of them as Traditional IRAs on steroids—you can contribute much more, potentially up to $70,000 or 25% of your compensation (whichever is lower) in 2025. Like Traditional IRAs, contributions are tax-deductible, investments grow tax-deferred, and withdrawals in retirement are taxed as ordinary income. However, keep in mind, SEP IRAs must treat all eligible employees equally, meaning if you contribute for yourself, you must also contribute proportionately for your employees.
Taxable Brokerage Account – this is just a normal investment account, meaning no special tax favors, though they can still be quite tax-efficient. You invest with after-tax dollars, and there’s no limit to how much you put in or take out. It’s totally flexible – buy or sell anytime. You’ll pay taxes on interest or dividends each year and on any capital gains when you sell investments. The good news: long-term capital gains and qualified dividends are taxed at lower rates (0%, 15%, or 20% depending on your bracket), not at your high ordinary income rate. And if you hold investments until death, your heirs may get a tax break via a “step-up” in cost basis. Unlike retirement accounts, there are no penalties for withdrawal at any age, and no required withdrawals ever. Think of brokerage accounts as extremely flexible, but offering no built-in tax shelter.
Why so many account types? Because each is a trade-off between immediate tax benefits, future tax benefits, flexibility, and rules. The key is to use each account in the right way so you’re not paying more tax than necessary.
Put the Right Investments in the Right Bucket
Now that we have the basic definitions, let’s talk about tax-efficient investing. This is about deciding which investments to hold in which account to minimize taxes – a concept known as asset location. Not all income is taxed equally:
| Investment Type | How It's Taxed |
|---|---|
| Interest from Bonds or CDs | Taxed at high ordinary income rates (up to 37% federal). |
| REIT Dividends | Also taxed at ordinary income rates (up to 37% federal). |
| Stock Gains | Taxed at lower capital gains rates (0%, 15%, or 20%) when sold after holding for more than one year. |
| Stock Dividends | You'll owe capital gains taxes on qualified dividends. |
| ETFs (Exchange-Traded Funds) | Generally more tax-efficient than mutual funds. Capital gains taxed only when you sell shares. |
| Mutual Funds | May distribute capital gains even if you don't sell your shares, potentially creating unexpected tax liability. |
Traditional wisdom: Put tax-inefficient assets (taxable bonds, REITs, high-turnover funds) into tax-deferred accounts (401(k)/Traditional IRA) where the interest/dividends won’t be taxed yearly. Meanwhile, hold tax-efficient assets (stocks, index funds, ETFs) in taxable brokerage accounts, where you can take advantage of lower long-term capital gains rates. This way, your bond interest (which would’ve been taxed up to 37% as regular income) is sheltered in an IRA/401(k) until withdrawal, and your stock gains (taxed at 0-20%) are in taxable where the rates are gentler.
What about Roth accounts? Roths are the holy grail of tax shelters since qualified withdrawals are completely tax-free. That means you may want your highest-growth, most tax-hungry investments in a Roth. If you have an aggressive stock or a startup investment (à la Peter Thiel), the Roth IRA is its dream home – all that growth won’t cost you a dime in tax. In contrast, putting a hyper-growth stock in a Traditional IRA means you’ll owe income tax on the entire gain at withdrawal, and in a taxable account, you’ll owe capital gains tax when you sell.
That said, asset location isn’t one-size-fits-all. Your overall allocation (mix of stocks/bonds) should drive things first. And some analyses note that if you have a very long time horizon, holding stocks in tax-deferred accounts can be just as good or better because decades of tax-free compounding can outweigh the higher tax on withdrawal. In other words, the old “bonds in IRA, stocks in taxable” rule of thumb can flip for young investors who won’t touch their IRA for 30+ years. The nuance is deep, but the simple takeaway is: place investments where they’ll lose the least to taxes.
| Account Type | Optimal Investments |
|---|---|
| Taxable Account Taxed annually on dividends, interest, and capital gains when sold |
|
| Traditional IRA/401(k)/SEP IRA Tax-deferred growth; taxed as ordinary income upon withdrawal |
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| Roth IRA/401(k) Contributions made with after-tax dollars; qualified withdrawals are completely tax-free |
|
Smart Withdrawal Strategies to Minimize Taxes in Retirement
Okay, you’ve saved and invested wisely—now you’re at the doorstep of retirement (or already there), and it’s time to use this money. How do you withdraw from these different accounts in a tax-efficient way? The order and strategy can make a big difference in how long your money lasts.
Conventional wisdom says to tap your accounts in this order:
Your first funding priority for flexibility and access:
- No contribution limits
- No withdrawal penalties
- Immediate access to funds when needed
- Lower tax rates on long-term investments
Perfect for emergency funds and future business opportunities that might require quick access to capital.
Your second funding priority for current tax advantages:
- Traditional/SEP IRA or 401(k)
- Immediate tax deductions on contributions
- Tax-deferred growth until withdrawal
- Higher contribution limits than Roth IRA
Ideal when you want to reduce current taxable income, especially during high-earning years in your business.
Your third funding priority for future tax-free growth:
- No tax benefits now, but tax-free withdrawals later
- Tax-free earnings growth
- More flexible withdrawal rules than traditional IRAs
- No required minimum distributions (RMDs)
Best for long-term wealth building when you expect to be in a higher tax bracket in retirement.
The idea is to let the money in tax-advantaged accounts keep growing as long as possible, since once you pull it out, the tax shelter ends. By spending down your taxable dollars early, you also potentially harvest lower capital gains taxes (or even 0% capital gains if you’re in a low bracket). Meanwhile, the IRA keeps compounding tax-deferred, and the Roth compounds tax-free.
For many, this default approach works well. For example, in your 60s you might first sell investments from your brokerage account and use those for income (realizing any capital gains at preferential rates). Once your brokerage assets are depleted or when RMDs kick in at 73, you’d then take required (and additional needed) withdrawals from the Traditional IRA/401(k). You’d only tap Roth IRA funds last, when other accounts are exhausted (or for extra spending needs), preserving that sweet tax-free growth as long as possible.
However, one size doesn’t fit all in a drawdown strategy either. Here are a few considerations:
Fill up low tax brackets: If your taxable income is very low in the early years of retirement, it can make sense to intentionally withdraw some from your Traditional IRA (or do Roth conversions) even if you don’t need it, just to use up, say, the 0% or 10% or 12% brackets. Why leave that bracket “space” unused? For instance, you might take enough from the IRA each year to fully utilize your standard deduction (tax-free) and the lower tax brackets. This reduces your IRA balance (and future RMDs) and effectively shifts some money to Roth or taxable at low cost.
Consider capital gains 0% zone: Conversely, if you have large appreciated stocks in your taxable account, check if you fall in the 0% capital gains bracket (for 2025, roughly up to ~$48k taxable income for singles, ~$96k for couples, you pay 0% federal tax on long-term gains). If so, realizing gains from your brokerage in those years can be hugely tax-efficient. You’d be spending taxable assets first anyway, but be strategic about capturing gains while they’re tax-free.
Delay Social Security to manage taxes: This isn’t a SS seminar, but note that until you start Social Security (or a pension), your taxable income might be lower, which can potentially allow more IRA withdrawals at a lower tax rate.
Use Roth for spikes: If you have a year with a big expense (buying a car, medical bill, etc.) that requires extra funds, consider taking that from your Roth IRA if possible. Roth withdrawals won’t increase your taxable income, so they won’t cause your tax bracket to jump or your Medicare premiums to spike.
Qualified Charitable Distributions (QCDs): If you’re charitably inclined and over 70½, you can withdraw from your Traditional IRA directly to a charity tax-free (up to $100k/year). This satisfies RMDs without adding to your taxable income. It’s a niche strategy but extremely effective for those who were going to donate anyway—essentially making those IRA withdrawals tax-free by giving to charity instead of taking as income.
You may want to consider donating appreciated stock from your taxable brokerage account as well. By giving stocks directly to charity, you can potentialy avoid capital gains tax and still snag a charitable deduction for the full market value!
In general, a blended approach may work best, and as always, it depends on your income sources, balances, and goals.
Visualizing the Tax Differences
Let’s translate some of this tax talk into visuals. Below is a simple chart that compares the after-tax value of a $50,000 withdrawal from three different accounts: a Traditional IRA, a Roth IRA, and a taxable Brokerage account. I’m assuming a moderate tax scenario (22% income tax bracket for the Traditional IRA withdrawal and 15% long-term capital gains tax on the brokerage withdrawal for illustration).
As you can see, the Roth IRA shines for tax-free income—every dollar you take out is yours to keep. The Traditional IRA withdrawal triggers a chunk of taxes, leaving you with less net money. The brokerage withdrawal falls in between (some tax, but typically less than traditional if long-term capital gains rates apply). This is why having a mix of account types can be powerful: you gain flexibility to manage your tax bill in retirement.
Wrapping Up – Plan Now, Pay Less Later
By withdrawing in a planned manner and having your investments in their proper places (though it’s probably impossible to say there’s an optimal asset allocation strategy because investments go up and down and taxes change), you can potentially add tens or hundreds of thousands of dollars to your retirement bottom line over the years.
Importantly, none of this is about tax evasion or sketchy schemes – it’s about using the incentives and rules Congress built (perhaps unintentionally in Thiel’s case!) to your advantage. It’s perfectly legal and smart to arrange your finances efficiently.
If your head is spinning or you’re unsure how to apply these ideas, that’s completely normal. Tax planning and retirement distribution strategies are complicated, even for math-inclined folks. This is where I can help. I’ll help you figure out a good mix of Traditional vs Roth, identify opportunities for tax savings, and craft a retirement withdrawal plan so you keep as much of your hard-earned money as possible. All you have to do is click the button below.
Here’s to making the tax code work for you!
Sources:
- https://www.propublica.org/article/lord-of-the-roths-how-tech-mogul-peter-thiel-turned-a-retirement-account-for-the-middle-class-into-a-5-billion-dollar-tax-free-piggy-bank
- https://www.investopedia.com/brokerage-account-vs-roth-ira-5222244
- https://www.fidelity.com/viewpoints/retirement/spender-or-saver
- https://www.missionsq.org/products-and-services/iras/ira-vs-brokerage-account-whats-the-difference.html
- https://www.kitces.com/blog/asset-location-for-stocks-in-a-brokerage-account-versus-ira-depends-on-time-horizon
