Building a cash savings and making sure you get any company match in a 401-k is important, but today I want to write about the value of saving in taxable investment accounts. I think there are two key benefits to after-tax investments.

1. Liquidity – In a taxable brokerage account, you have access to the funds any time you need them. If you want to buy a house, need to pay a medical bill or simply like knowing you have access to funds if a need arises, money in a taxable account can provide flexibility and peace of mind. 401k and Traditional IRAs have tax consequences and steep penalties for withdrawals before you turn 59 ½. Some will argue that not having access to the funds will keep you from using the money frivolously before you need it. That is something to consider, but there is something to be said for access to cash and personal discipline.
2. No Future Tax Liability – Since you pay taxes on the money put into a taxable investment account and pay capital gains/dividend taxes annually, the money in a taxable account is 100% yours. You can withdraw money whenever you need, as much as you need and not generate taxable income. With a 401k or a Traditional IRA, every withdrawal creates taxable income, taxed at your marginal rate. That could be 25% or higher. For example, if you have $200k in a 401k plan, at a 25% marginal tax rate, you have a $50k future tax liability, so you really only have $150k.

I’m not suggesting people shouldn’t take advantage of the benefits of tax-deferred accounts. And if you are eligible for a Roth IRA, that is a great savings vehicle as well because you get the benefits of tax-deferred growth, don’t pay taxes on withdrawals and can always withdraw your contributions without penalty. However, there are income restrictions and you can only put $5k a year into a Roth. I’m suggesting after-tax investments should be part of your retirement savings plan.

The conventional wisdom says to maximize savings in tax-deferred investment accounts. I think there is a lot of value in that advice, but I also think the companies that provide 401k plans and IRAs benefit tremendously if you don’t have access to your funds. They are essentially guaranteed years of fee-income once you make a deposit, so their recommendation to focus your savings plan in those types of accounts might not always be in your best interest. You have to find the right balance for you personally, but hopefully I’ve helped you think about some of the benefits of after-tax investment savings.

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One inexpensive way to take advantage of the compounding power of dividends is through Dividend Reinvestment Programs offered directly from a company. After an initial investment of between $50-500, you can buy shares every month with a direct transfer from your bank account, generally with a $25 minimum. Computershare is one of the largest managers of these programs, but other financial institutions offer then as well.

The basic premise is similar to how you can slowly buy shares in a mutual fund, but this allows you to invest in a specific company. Once a month, a direct transfer goes from your bank account to the program administrator and shares are purchased. For example, if you invest $100 a month into a stock with a $50 share price, you will buy 2 shares that month. If the share price is $75, you will buy 1.33 shares.

When the company pays a dividend, the proceeds of the dividend will buy additional shares. When you first start out, the dividend will likely only buy a tiny fraction of a share, but as you keep investing, those additional shares add up and then pay you a better dividend in the future.

I personally participate in four separate DRIP programs – Procter & Gamble (PG), United Technologies (UTX), McDonalds (MCD) and Southern Company (SO). Procter & Gamble runs its program directly and has no fees. The other three are administered by Computershare and the fees vary by company, depending on how much the company subsidizes the program.

DRIP programs can be a great addition to your after tax savings program.

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