Taxable vs Tax-Advantaged Account Growth Comparison

Where you hold your investments matters almost as much as what you invest in. The same investment can produce vastly different after-tax returns depending on whether it sits in a taxable brokerage account, a Traditional 401(k)/IRA, or a Roth IRA. This calculator reveals the hidden cost of "tax drag"—the annual erosion of returns when taxes are paid yearly instead of deferred or avoided entirely.

Here's the core concept: In a taxable account, you pay taxes on dividends, interest, and realized gains each year. That money leaves your account and can't compound. In tax-advantaged accounts, either you pay taxes later (Traditional) or never on growth (Roth), allowing more money to stay invested and compound over time.

Over 20-30 years, tax drag can cost you tens or even hundreds of thousands of dollars in lost growth. This calculator models the difference, showing how the same contributions and returns can produce dramatically different outcomes based solely on account type and tax treatment.

Understanding this dynamic helps you make smarter decisions about where to save first, how to allocate investments across accounts, and when taxable accounts might actually make sense despite their tax disadvantages.

Taxable Brokerage Accounts

Regular brokerage accounts have no contribution limits and offer full flexibility— withdraw anytime without penalties. But every year, you owe taxes on:

• Dividends: Qualified dividends taxed at 0-20%; ordinary dividends at income rates
• Interest: Taxed as ordinary income (federal rates up to 37%)
• Capital gains: Short-term at income rates; long-term at 0-20%

This "tax drag" reduces the money available to compound. Even at "low" rates like 15%, paying taxes annually significantly impacts long-term growth.

Traditional (Tax-Deferred) Accounts

Traditional 401(k)s, IRAs, and similar accounts defer taxes until withdrawal:

• Contributions: Pre-tax (reduce taxable income now)
• Growth: Tax-deferred (no annual tax drag)
• Withdrawals: Taxed as ordinary income in retirement

The advantage: 100% of your money stays invested and compounds. You pay taxes eventually, but potentially at a lower rate in retirement and after decades of tax-free growth.

Roth (Tax-Free Growth) Accounts

Roth 401(k)s and IRAs offer a different trade-off:

• Contributions: After-tax (no current deduction)
• Growth: Completely tax-free
• Withdrawals: 100% tax-free in retirement

You pay taxes upfront on contributions, but all growth—potentially decades of compounding—is never taxed. For long time horizons, this can be incredibly powerful.

The Tax Drag Effect

Tax drag is the percentage of your returns lost to annual taxes. A 7% return with 1% annual tax drag effectively becomes 6% net growth. Over 30 years, this 1% difference can reduce your final balance by 25% or more compared to tax-free growth.

Step 1: Set Your Investment Timeline

Enter how many years you plan to invest. Longer time horizons amplify tax drag effects— the difference between taxable and tax-advantaged becomes more dramatic over 20-30+ years.

Step 2: Enter Starting Balance and Contributions

Input your starting balance and planned annual contributions. The calculator applies the same amounts to both account types for fair comparison. Note: tax-advantaged accounts have contribution limits in reality.

Step 3: Set Your Expected Return

Enter your expected annual investment return (e.g., 7% for diversified stock portfolios). Both accounts will use this return, but the taxable account will have returns reduced by tax drag.

Step 4: Enter Tax Drag Rate for Taxable Account

Estimate the annual tax drag on your taxable investments. This depends on investment type and your tax bracket. Index funds might have 0.5-1% drag; dividend stocks or actively managed funds might be 1-2%+. This is the percentage of your balance lost to taxes each year.

Step 5: Choose Tax-Advantaged Account Type

Select Roth-style (pay taxes now, grow tax-free) or Traditional-style (deduct now, pay taxes on withdrawal). Enter your current tax rate and expected retirement tax rate.

Step 6: Compare the Results

Review the year-by-year projections and final after-tax values. See how much extra wealth the tax-advantaged account could generate and the total tax drag cost of the taxable account.

Taxable Account Growth (With Tax Drag)

Each year, returns are reduced by taxes paid:

Example: 7% gross return, 15% effective tax on returns:
After-Tax Return = 7% × (1 - 0.15) = 7% × 0.85 = 5.95%

Tax-Advantaged Account Growth

No annual tax drag—full returns compound:

The same 7% return stays 7%. Over time, this difference compounds dramatically.

Example: 30-Year Comparison

$10,000 initial + $5,000/year for 30 years at 7% return:

• Taxable (1.5% annual tax drag): ~$420,000 final balance
• Tax-Advantaged (no drag): ~$560,000 final balance
• Difference: ~$140,000 lost to tax drag over 30 years

After-Tax Value Calculation

For fair comparison, adjust for taxes due on withdrawal:

Even accounting for taxes due on Traditional withdrawals, tax-advantaged accounts typically win because decades of tax-free compounding outweigh the eventual tax bill.

Scenario 1: Young Investor Starting Out

Situation: Sam, 25, can invest $6,000/year. Deciding between maxing Roth IRA or using a taxable brokerage. 40-year horizon. 22% current tax rate.

Analysis: At 7% returns with 1% tax drag in taxable, the Roth IRA ends up with ~$1.3M after 40 years (all tax-free). The taxable account ends around ~$1.0M (mostly already taxed). Roth advantage: ~$300,000.

Recommendation: Max the Roth IRA first. The 40-year tax-free compounding is too valuable to pass up. Use taxable only after maxing tax-advantaged.

Scenario 2: High Earner Exceeding Retirement Limits

Situation: Maria, 40, maxes her 401(k) ($23,000) and backdoor Roth ($7,000) but wants to invest an additional $20,000/year. Must use taxable account.

Analysis: For money that must go to taxable, minimize tax drag by using tax-efficient investments (index funds, ETFs, municipal bonds). At 0.5% effective drag, the cost is much lower than dividend-heavy or actively managed funds at 2%+ drag.

Recommendation: Always max tax-advantaged first. In taxable, use tax-efficient index funds and hold for long-term capital gains. Consider tax-loss harvesting to offset gains.

Scenario 3: Comparing Traditional vs Taxable

Situation: Alex, 35, in the 32% bracket, debates Traditional 401(k) vs taxable investing. Expects 22% bracket in retirement.

Analysis: Traditional 401(k): Deduct at 32%, grow tax-free, pay 22% on withdrawal. Taxable: Pay 32% on contribution (after-tax dollars), then annual tax drag, then capital gains on sale. Traditional wins by a wide margin due to both the rate differential and no tax drag.

Recommendation: Traditional 401(k) is significantly better. The combination of upfront deduction and no tax drag overwhelms taxable account flexibility.

Scenario 4: Short Timeline—Does It Matter?

Situation: Jordan, 55, has 10 years until retirement. Extra $10,000 to invest annually. Wondering if tax-advantaged vs taxable matters with shorter horizon.

Analysis: Even over 10 years, a 1% annual tax drag costs ~8-10% of final value. Tax-advantaged still wins, though the gap is smaller than 30+ year horizons.

Recommendation: Still prioritize tax-advantaged, but the advantage is less dramatic. Catch-up contributions ($7,500 extra for 401k at 50+) become valuable.

Scenario 5: Early Access Needs

Situation: Casey, 30, wants to retire at 45. Needs money accessible before 59½. Considering all taxable for flexibility.

Analysis: Taxable offers flexibility but at significant cost. Better strategy: Max Roth IRA (contributions withdrawable anytime), use Roth conversion ladder, and only use taxable for the 5-year bridge period before Roth access.

Recommendation: Don't avoid tax-advantaged entirely. Mix strategies: Roth for accessible contributions, taxable only for specific early-retirement bridge needs.

• ❌ Using taxable accounts before maxing tax-advantaged: Unless you need the money before retirement or have already maxed all tax-advantaged options, the tax drag cost almost never justifies taxable account flexibility.
• ❌ Holding tax-inefficient investments in taxable accounts: High-yield bonds, REITs, and actively managed funds with frequent distributions should go in tax-advantaged accounts. Index funds and growth stocks are more tax-efficient for taxable.
• ❌ Ignoring tax-loss harvesting in taxable: When you must use taxable accounts, harvest losses to offset gains and reduce tax drag. Don't let the tax drag be higher than necessary.
• ❌ Underestimating long-term tax drag impact: 1% annual drag seems small, but over 30 years it can cost 20-30% of your potential balance. The compounding effect makes small percentages matter enormously.
• ❌ Choosing taxable for "flexibility" you never use: Many investors cite flexibility but never actually withdraw before retirement. You're paying for optionality that may never be used.
• ❌ Not considering state taxes: State income taxes add to tax drag. If you're in a high-tax state now but might retire to a no-tax state, Traditional accounts become even more attractive.
• ❌ Forgetting about HSA triple tax advantage: If eligible, HSAs offer tax deduction, tax-free growth, AND tax-free withdrawal for medical expenses— better than even Roth for healthcare costs.

1. Asset Location Optimization

Place assets strategically across account types. Tax-inefficient assets (bonds, REITs, high-dividend stocks) go in tax-advantaged accounts. Tax-efficient assets (index funds, growth stocks, municipal bonds) go in taxable. This minimizes overall tax drag while maintaining your target asset allocation.

2. Tax-Loss Harvesting in Taxable Accounts

Sell investments at a loss to offset gains, reducing tax drag. Immediately buy similar (not identical) investments to maintain exposure. This converts taxable events into tax deductions. Can save 0.5-1% annually on tax drag when done systematically.

3. Use Index Funds in Taxable Accounts

Index funds minimize distributions through low turnover and can use "heartbeat trades" to purge embedded gains. Some index funds have near-zero distributions, minimizing annual tax drag to just the qualified dividend rate.

4. Consider Municipal Bonds for High Earners

For taxable fixed-income holdings, municipal bonds offer federally tax-exempt interest. In-state munis may also be state-tax-free. The tax-equivalent yield can exceed taxable bonds for high-bracket investors.

5. Contribute to All Account Types (Tax Diversification)

Having money in Traditional, Roth, and taxable accounts gives flexibility in retirement. You can manage taxable income by choosing which accounts to draw from, potentially staying in lower brackets and managing Medicare premium impacts.

6. Donate Appreciated Shares

If you make charitable donations, donate appreciated shares from taxable accounts instead of cash. You get the full deduction without paying capital gains tax on the appreciation. This effectively eliminates years of accumulated tax drag.

7. Step-Up in Basis at Death

Unrealized gains in taxable accounts receive a "step-up" in cost basis at death, eliminating capital gains taxes for heirs. For estate planning purposes, holding appreciated assets in taxable accounts until death can be strategically advantageous.