3339: A Surprising Contender for Tax-Efficient Retirement Saving by Darrow Kirkpatrick of Can I Retire Yet

Summary

Podcast Summary: Optimal Finance Daily

Episode 3339: "A Surprising Contender for Tax-Efficient Retirement Saving" by Darrow Kirkpatrick
Host: Diania Merriam
Date: November 2, 2025

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Main Theme

This episode explores a fresh look at retirement saving strategies, focusing on the real-world effectiveness of different account types—taxable, tax-deferred, and tax-free (e.g., Roth)—for tax efficiency. Drawing from Darrow Kirkpatrick's analysis on CanIRetireYet.com, Diania Merriam shares data-driven insights that challenge the standard advice and highlight scenarios where taxable accounts can rival or even exceed traditional retirement accounts in building wealth, especially for those in lower tax brackets.

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Key Discussion Points & Insights

1. The Conventional Wisdom

• Most advice recommends maximizing contributions to tax-advantaged accounts like IRAs and 401(k)s.
• The logic: avoiding taxes both accelerates wealth accumulation and keeps money compounding.

2. Questioning the Status Quo

• Darrow Kirkpatrick asks: How much better are tax-advantaged accounts, really? Is there a meaningful performance difference?
• What about the impact of investment returns' composition: dividend versus capital gains?

3. Simulation Setup [02:00-04:30]

• A case study of a couple earning $75,000/year, saving $10,000/year from age 30 to 65.
• Retirement at 65, living until 90; constant yearly spending of $50,000 and Social Security at $24,000/year.
• Investment return at 6%, inflation at 3%; tested across account types:
  • Taxable accounts
  • Tax-deferred accounts
  • Tax-free accounts (Roth)
• Each account type was tested with investments structured as:
  • 100% dividend-producing
  • 100% capital gains-producing
  • 50/50 split

4. Results & Detailed Comparison [04:30-07:20]

• Tax-free accounts generally perform best.
  • Provide steady income, keeping the saver in lower tax brackets in retirement.
  • "Tax free is better than tax deferred ... because it results in a level income stream that stays out of higher tax brackets." (Kirkpatrick, 05:36)
• Tax-deferred accounts lead until retirement, but RMDs (Required Minimum Distributions) later can push retirees into higher brackets, eroding the advantage.
• Taxable accounts: The surprising contender.
  • If focused on investments that generate primarily capital gains and withdrawals are timed in lower brackets, their ending net worth can nearly match tax-free accounts.
  • Key Data Table Highlights:
    • Taxable with 100% capital gains: $377,623 (nearly equal to tax-free with $377,640)
    • Taxable with 100% dividends: $151,832 (much lower)
  • "A taxable account with most of its growth coming from capital gains... if that growth is withdrawn in the lower two tax brackets, it's essentially equivalent to a tax free retirement account." (Kirkpatrick, 08:22)

5. Investment Type Matters Most in Taxable Accounts [07:20-08:50]

• Dividends in taxable accounts are taxed yearly, reducing compounding power.
• Capital gains are taxed only on realization, and in lower brackets, often not taxed at all.

6. Flexibility and Practical Considerations

• Taxable accounts have fewer usage and withdrawal rules–an advantage for flexibility.
• Practical caveats:
  • 100% equity portfolios aren’t ideal for everyone—a portion should be stable for emergencies.
  • Most investors will hold some dividend-paying assets.

7. Takeaway: Not Just About Account Type, But Tax Bracket and Asset Type

• For savers in lower tax brackets, a taxable account focused on capital gains can be as effective as a traditional tax-free account.

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Notable Quotes & Memorable Moments

• "The tax status of your investment returns, whether dividends or capital gains, does not matter for retirement accounts. That's because withdrawals from these accounts, when they're taxed at all, are taxed at ordinary income rates." – Darrow Kirkpatrick, [06:35]
• "A taxable account with most of its growth coming from capital gains ... is essentially equivalent to a tax free retirement account." – Darrow Kirkpatrick, [08:22]
• "For most people, those [retirement] accounts are the best starting point for retirement saving ... but owning capital gains-generating securities as much as possible in your taxable accounts can pay off big time over the long haul, especially if you live in the lower tax brackets." – Darrow Kirkpatrick, [09:20]
• "A tax smart approach to retirement saving and living can easily increase your ending net worth by 25 to 50% or more, but that doesn't necessarily require a tax sheltered account." – Darrow Kirkpatrick, [10:20]
• "So when it comes to your retirement money and taxes, it's best not to play so high. Whether you choose to save in tax advantaged accounts or live in lower tax brackets, or both, your finances will do better in the long run. And just to be safe, I'd avoid cheating at cards too." – Darrow Kirkpatrick, [10:50]
• "Make sure we’re not sacrificing dollars to save pennies." – Diania Merriam, [13:13]

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Timestamps for Key Segments

• [02:00-04:30] – Scenario and assumptions for simulation
• [04:30-07:20] – Account type outcomes and discussion
• [07:20-08:50] – Significance of capital gains versus dividends in tax efficiency
• [09:00-11:00] – The flexible upside and limitations of taxable accounts
• [13:13] – Diania's summary commentary and caveats on early retirement tactics

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Host Commentary: Summary & Actionable Thoughts

• Diania underscores the value of prioritizing retirement accounts for their tax benefits and simplicity.
• Addresses fears about early retirement and withdrawal penalties, mentioning workarounds like Roth conversion ladders and SEPP 72(t) distributions.
  • Recommends Mad Fientist’s article “How to Access Retirement Funds Early” for those worried about access before traditional retirement age.
• Quote: "I would like to encourage us all to make sure we're not sacrificing dollars to save pennies." (Diania Merriam, 13:13)
• Emphasizes the importance of personalizing strategies to individual situations—what works best will vary.

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Conclusion

The episode challenges the notion that taxable investment accounts are always inferior for retirement savings. For people in lower tax brackets, a properly managed taxable account—principally holding long-term, capital gains-generating assets—can result in nearly identical outcomes to tax-free accounts like Roth IRAs, without the restrictions. However, for most people, prioritizing traditional retirement accounts is still optimal. Tax strategy, account choice, and asset allocation are all crucial levers on the road to financial independence.

Final advice: Use all available tactics to minimize lifetime taxes—whether that’s by choosing smart accounts, living in lower tax brackets, or implementing asset strategies that maximize after-tax returns.

Transcript

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This is optimal Finance Daily A Surprising Contender for Tax Efficient Retirement Savings By Darrow Kirkpatrick of caniretireyet.com Samuel Foote, famous British comedic actor of his time, was chatting with a member of the Royal Court. The entitled aristocrat complained bitterly of having been thrown out a second floor window for cheating at cards. Foote's advice don't play so high One secret to successful retirement saving, in addition to getting started, is to avoid paying taxes, especially in high income tax brackets. When you put your retirement money into play at higher tax rates, the government gets more of it. If instead you can limit or smooth out your income staying out of those high tax brackets, you'll keep more of your money over time. The conventional advice is to do your retirement saving in tax advantaged accounts such as traditional and Roth IRAs and 401s. Your savings will simply grow faster when liberated from an annual tax levy. That conventional advice makes sense in almost all cases, and most of us have accepted it without much question. But I recently found myself wondering about that conventional wisdom. Just how much better are tax sheltered retirement accounts? How much faster does your savings grow in a retirement account than a taxable investment account? And is there a significant difference in the performance of different types of retirement accounts over the long run? How much does the choice of accounts really matter? And speaking of tax matters, what is the impact on your money of the types of returns those accounts produce? Does it matter if your investments produce primarily dividends, usually taxed at your marginal income tax rate as soon as they're received, or if they produce primarily capital gains, usually taxed at lower rates, and not until you actually realize those gains by selling securities? I ran a series of retirement simulations to find out research for my analysis. I used a high fidelity retirement calculator that automatically performs detailed tax calculations each year with all the relevant tax provisions, including inflation adjusted tax brackets. It also computes required minimum distributions or RMDs from a tax deferred account after age 70, and it handles the taxation of capital gains as they're realized at reduced rates. In order to focus on just a few variables, I created a simple scenario. A hypothetical couple that chooses to save for retirement exclusively in one type of account holding a single type of asset class. They save into this one account for their entire working career and then live off that same account plus Social Security during retirement. The couple earns 75,000 annually over the course of their careers and spends $50,000 annually on expenses both while working and in retirement. Their Social Security benefit, equal to $24,000 in today's dollars, starts at age 65. Their return on cash is 0% and and their return on investments is 6%. Inflation runs at 3%. The couple starts saving at age 30, continuing until their retirement at age 65. Each year of their working career, they contribute $10,000 in savings to their single retirement account. I analyzed what happens when that savings accumulates in each of the three possible types of accounts taxable, tax deferred and tax free. I also investigated the difference between putting that money in investments that produce dividends only or capital gains only or a 5050 mixture retirement accounts. For each combination of account and investment variables, I ran the simulation up until the couple reached age 90, then recorded their ending net worth in today's dollars. Here are the results of the amount of money the couple has left at age 90 for for each type of account and investment return. If Investment return is 100% dividends, $377,640 is tax free, $340,293 is tax deferred, then $151,832 is taxable. If investment return is 50% dividends, 50% capital gains, $377,640 is tax Free, $340,293 is tax Deferred, then $275,079 is taxable, and if investment returns is 100% capital gains, $377, 640 is tax free, $340, 293 is tax deferred, and then $377,623 is taxable. The first thing to notice is that the tax free account generally does best. Tax free is better than tax deferred in this scenario because it results in a level income stream that stays out of higher tax brackets. That said, the tax deferred option is ahead until retirement age 65 due to the way it reduces taxes. Contributions to tax deferred accounts are subtracted from taxable income, but then the tax deferred option loses out because withdrawals from the tax deferred account, including RMDs, push the couple into a higher tax bracket more often during retirement. The average effective tax rate for the tax deferred option is about 2.5% higher than the tax free. Looking at the results mentioned, we can also easily see that the tax status of your investment returns, whether primarily dividends or capital gains, does not matter for retirement accounts. That's because withdrawals from these accounts when they're taxed at all are taxed at ordinary income rates. So it doesn't matter whether the account growth is due to bonds producing dividends or stocks producing capital gains. The tax consequences are the same either way, and we see that demonstrated in the identical ending values regardless of the composition of tax free or tax deferred accounts. Taxable Accounts this is not true for taxable accounts.

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The results show that investments producing ordinary taxable income in taxable accounts underperformed dramatically over the long haul. The taxable account with dividend income was worth less than one half of the same account with capital gains. That's because not only are capital gains not taxed until securities are sold, allowing more time for investments to compound, but they aren't taxed at all if you're in the lower two tax brackets. And in fact, this couple spends most of their working and retired life in those lower 10 and 15% tax brackets. Now compare the ending value of that taxable account with 100% capital gains to that of the tax free account. Remarkably, a taxable account with most of its growth coming from capital gains. If that growth is withdrawn in the lower two tax brackets, it's essentially equivalent to a tax free retirement account. That's because in either case, the growth is not taxed. Also note that this particular couple would actually have been better off saving in a taxable account than a tax deferred account if they were willing to deal with the volatility of owning primarily stocks in that taxable account. And while most taxable accounts can't outperform the average tax free account, they do have one clear far fewer rules about what you can and can't do with your money. Am I suggesting that you forego the traditional retirement savings vehicles Absolutely not. For most people, those accounts are the best starting point for retirement saving, and the additional rules and barriers for accessing that money are actually a good thing if they provide motivation to leave that money alone and invest for the long haul. Also, you'd rarely want 100% equities in your taxable accounts. That's because at least one of those accounts should probably be serving as an emergency fund. You need stable cash or bonds that you can draw on in a pinch without penalties and without regard for what the market is doing at the time. Finally, equities themselves typically generate some dividends. But even if you don't follow this example to the extreme, there's much to be learned from it. Owning capital gains, generating securities as much as possible in your taxable accounts can pay off big time over the long haul, especially if you live in the lower tax brackets. Conclusion the conventional advice about retirement saving is correct. For the most part, smart retirement saving is all about deferring and reducing taxes. You want to pay taxes later, and you want to smooth your income if possible. So you pay those taxes from lower tax brackets. But you might not appreciate how important that is until you study those numbers I mentioned. A tax smart approach to retirement saving and living can easily increase your ending net worth by 25 to 50% or more, but that doesn't necessarily require a tax sheltered account. The conventional wisdom leaves out one surprising contender for tax efficient retirement savings for those in the lower tax brackets. A taxable account holding the right kind of assets, those that primarily generate capital gains, can be very nearly as effective as the best retirement account. So when it comes to your retirement money and taxes, it's best not to play so high. Whether you choose to save in tax advantaged accounts or live in lower tax brackets, or both, your finances will do better in the long run. And just to be safe, I'd avoid cheating at cards too. You just listened to the post titled A Surprising Contender for Tax Efficient Retirement Saving by Darrell Kirkpatrick of caniretireyet.com Imagine.

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See dell.com for details. I liked this article because for the most part, it's a great reminder to prioritize retirement vehicles when you're deciding on where to put your money. The tax benefits are just too good and it really simplifies the process when you're making decisions on how to invest. Also, many people who want to retire early worry about putting too much into their retirement vehicles and needing to pay penalties to access their money before traditional retirement age. But remember, there are strategies to get around this like a Roth conversion ladder or setting up SEP72T distributions. Also remember that your Roth contributions can be accessed tax and penalty free. It's your investment gains that would be subject to taxes and penalties. I'd encourage you to read the article how to Access Retirement Funds early by the mad fientist who debunks this idea that if you want to retire early, you should prioritize investing in taxable accounts over fully funding your retirement vehicles. He provides in this article a hypothetical early retiree drawdown strategy, and the surprising conclusion is that even if you don't want to mess with things like Roth conversion ladders or SEP distributions, it still makes sense to fully fund your retirement vehicles. In his example, it made more sense to pay the penalty on early withdrawals over investing in an after tax brokerage account. But let me be clear, this isn't financial advice, and you may have some nuances to your situation where it really doesn't make sense to fully fund your retirement vehicles. However, I would like to encourage us all to make sure we're not sacrificing dollars to save pennies. And that will do it for another edition of Optimal Finance Daily. Have a great day. Thank you for listening, and be sure to come back tomorrow for more Where Optimal Life awaits.