Why does tax drag matter?

In taxable accounts, dividends and capital gains distributions are taxed each year, reducing the amount that compounds. Over 30 years at 8% gross return with 2% dividend yield, tax drag of 0.3-1.0% per year costs 10-25% of ending wealth compared to tax-sheltered accounts. The compounding effect of tax drag is significant.

What about the tax deduction for Traditional contributions?

Traditional contributions reduce current taxable income (tax deduction). For a fair comparison, the tax savings should be invested. Many comparisons assume same nominal contribution to both Roth and Traditional, which understates Traditional's actual outcome. The "fair" comparison: same out-of-pocket cost (Traditional contribution + invest tax savings vs. Roth contribution).

When should I use taxable accounts?

After maxing all tax-advantaged options: employer 401(k) match, IRA, 401(k) to limit, HSA if eligible. Taxable accounts are useful for: bridge years to retirement (early retirement), goals before traditional retirement age, and amounts above tax-advantaged limits. For high-savings households, taxable accounts often hold the majority of investment assets simply because tax-advantaged caps are too low to absorb all savings.

How do I minimize tax drag in taxable accounts?

Strategies: (1) hold tax-efficient assets — broad market index ETFs/funds with low dividend yields and low turnover; (2) place tax-inefficient assets (REITs, bonds, dividend stocks) in tax-advantaged accounts; (3) use long-term holding periods to qualify for LTCG rates rather than short-term ordinary income rates; (4) practice tax-loss harvesting to offset gains; (5) avoid mutual funds with high capital gains distributions in favor of ETFs with similar holdings but lower distributions.

Taxable vs Tax-Deferred Calculator

Q: Which account type is best?

It depends on your current vs. future tax rates. Roth (tax-free) generally wins when retirement rate is similar to or higher than current rate. Traditional (tax-deferred) wins when current rate is meaningfully higher than expected retirement rate AND tax savings are invested. Taxable accounts almost always lose to tax-advantaged accounts due to annual tax drag — they're useful when tax-advantaged limits are exhausted.

See how the same investment grows differently in a taxable brokerage account, a tax-deferred account (Traditional IRA/401k), and a tax-free account (Roth IRA/401k). Understand the impact of taxes on long-term investment growth.

Account type matters enormously for long-term investment outcomes. The same $10,000/year invested over 30 years produces dramatically different ending balances depending on whether it grew in a taxable brokerage account (taxed every year on dividends and at sale on gains), a tax-deferred account (Traditional 401k/IRA — no annual tax, ordinary income tax on withdrawal), or a tax-free account (Roth IRA/401k — no annual tax, no withdrawal tax). The differences come from "tax drag" — the slow erosion of returns from annual taxation in taxable accounts.

In a typical scenario (24% federal + 5% state combined marginal rate, 15% LTCG rate, 8% return with 2% dividend yield over 30 years), the after-tax outcomes differ substantially. Tax-free (Roth) typically produces the most after-tax wealth. Tax-deferred (Traditional) is usually close behind if retirement tax rate is similar to current rate. Taxable brokerage produces meaningfully less because of annual tax drag, even with the same gross investment performance.

This calculator compares all three account types for the same investment scenario, computing tax drag, total taxes paid, and ending after-tax wealth. Use it to understand why maxing tax-advantaged accounts before taxable investing matters, plan the optimal account-type mix for retirement contributions, and quantify the long-term cost of holding investments in less-tax-efficient locations.

Inputs

Annual Investment

Investment Period (years)

Annual Return

Dividend Yield

Portion of return from dividends (taxed annually in taxable accounts)

Current Tax Rate (%)

Retirement Tax Rate (%)

Capital Gains Tax Rate (%)

State Tax Rate (%)

Results

Taxable (After Tax)

$902,379

Tax-Deferred (After Tax)

$893,125

Tax-Free (Roth)

$868,656

Total Contributed

$300,000

After-Tax Value Comparison

Growth Comparison Over Time

Balance Growth by Year

Year	Taxable	Tax-Deferred	Tax-Free
1	$10,000.00	$10,800.00	$7,668.00
2	$20,760.00	$22,464.00	$15,949.44
3	$32,337.76	$35,061.12	$24,893.40
4	$44,795.43	$48,666.01	$34,552.87
5	$58,199.88	$63,359.29	$44,985.10
6	$72,623.07	$79,228.03	$56,251.90
7	$88,142.43	$96,366.28	$68,420.06
8	$104,841.25	$114,875.58	$81,561.66
9	$122,809.19	$134,865.62	$95,754.59
10	$142,142.68	$156,454.87	$111,082.96
11	$162,945.53	$179,771.26	$127,637.60
12	$185,329.39	$204,952.97	$145,516.61

Last updated: May 27, 2026Reviewed by the CalcMountain editorial team

Formula

Taxable account growth (annual tax drag): Each year: Capital appreciation: portion of return that's not dividends Dividend income: dividend yield portion, taxed annually as qualified dividend (15% federal + state) Effective annual return after tax drag ≈ Total Return − (Dividend Yield × Capital Gains Rate) Year-end value: Previous Balance × (1 + after-tax-return) + Annual Contribution At final sale (or withdrawal): Capital gains tax on accumulated gain = (Final Value − Cost Basis) × Capital Gains Rate After-tax value at end: Taxable After-Tax = Final Value − Capital Gains Tax on Sale Tax-deferred (Traditional 401k/IRA) growth: Each year: balance × (1 + full return) + contribution (no annual tax) At withdrawal: full balance taxed as ordinary income at retirement rate. After-tax value = Final Balance × (1 − Retirement Rate) Tax-free (Roth) growth: Each year: balance × (1 + full return) + contribution (no annual tax) At withdrawal: tax-free. After-tax value = Final Balance (no further tax) Example: $10K/year × 30 years at 8% gross return, 2% dividend yield, 24% federal + 5% state current rate, 22% retirement rate, 15% LTCG. Taxable: tax drag ~0.5%/year → effective 7.5% return. Final balance ~$1.03M. Capital gains tax on gain: ~$77K. After-tax: ~$953K. Tax-deferred (Traditional): grows at full 8% → $1.13M. Ordinary tax at retirement at 27% combined: $305K. After-tax: $825K. Tax-free (Roth): grows at full 8% → $1.13M. No further tax. After-tax: $1.13M. Wait — if Roth and Traditional both have the same balance, and Roth has no tax, why doesn't Roth always win? Because the comparison ignores that Traditional gave the upfront deduction. If you invest the tax savings ($10K × 24% = $2,400/year saved on taxes, invested in taxable for 30 years), Traditional's total result becomes more competitive. For equal after-tax CONTRIBUTION amounts: Roth wins when retirement rate > current rate; Traditional wins when current rate > retirement rate. For this scenario (same $10K nominal contribution): Roth > Traditional > Taxable.

How to use this calculator

Enter annual investment contribution.
Set investment period.
Set expected annual return.
Set dividend yield (the portion of return that's dividend income vs. capital appreciation).
Enter current marginal tax rate (used for tax savings on Traditional contributions and annual dividend tax).
Enter expected retirement tax rate (used for Traditional withdrawal calculation).
Enter capital gains tax rate (typically 15% for most investors; 20% for highest brackets; 0% for low income).
Enter state tax rate.
Review the comparison across all three account types.
For decision: max tax-advantaged accounts first (401k match, Roth IRA, full 401k contribution). Use taxable accounts for amounts above tax-advantaged limits.

Worked examples

Standard high earner scenario

$10K/year × 30 years. 8% return, 2% dividends. 32% federal + 7% state current. 22% retirement. 15% LTCG. Taxable: tax drag ~0.7%/year. Final $1.00M. Capital gains tax: $80K. After-tax: $920K. Traditional: $1.13M before tax. Tax at 22%: $249K. After-tax: $881K. Plus current tax savings ($3,900/year × 30 = $117K) if invested = additional $230K future value. Total: $1,111K. Roth: $1.13M after-tax (no further tax). For high earners moving to lower retirement brackets, Traditional + investing tax savings can match or beat Roth. Without investing tax savings, Roth wins clearly.

Tax-free state, moderate income

Texas resident. 22% federal + 0% state = 22% combined. $6K/year IRA contribution, 25 years, 8% return. Taxable: smaller tax drag (0.4%/year). Final $385K. Capital gains $30K. After-tax: $355K. Traditional: $440K. Tax 18%: $79K. After-tax: $361K. Roth: $440K (no tax). Roth clearly wins. The lower-tax environment narrows the differences but Roth still produces best after-tax outcome.

Late career, expecting much lower retirement bracket

Age 55, $20K/year × 10 years. Currently 32% federal + 7% state. Expecting 12% federal + 0% state in retirement (relocating to no-tax state with smaller spending). Tax savings from Traditional: $20K × 39% = $7,800/year × 10 = $78K of immediate tax savings. Traditional + investing tax savings: Traditional balance year 10: $313K. Tax at 12% retirement: $37,560. After-tax: $275K. Plus tax savings invested at 8% × 10 years: ~$117K Total: $392K Roth: $313K (no tax). Traditional wins substantially when retirement bracket is dramatically lower than current. The deduction now is worth much more than the tax-free withdrawal later.

When to use this calculator

Use this calculator when planning retirement contribution strategies, evaluating whether to add taxable brokerage savings on top of maxed tax-advantaged accounts, deciding between Traditional and Roth contributions, or understanding the long-term cost of tax drag in taxable accounts.

Pair with: Roth-vs-Traditional, Roth-vs-Traditional-401(k), IRA, 401(k), and compound-interest calculators.

Key practical insights:

1. **Always max tax-advantaged accounts first.** The tax efficiency advantage is substantial. Priority: employer 401(k) match → Roth IRA (or Traditional if high bracket) → 401(k) to full limit → HSA if eligible → taxable brokerage.

2. **Asset location matters.** Hold tax-inefficient assets (REITs, bonds, dividend-heavy stocks) in tax-advantaged accounts. Hold tax-efficient assets (broad market index funds with low dividend yields) in taxable accounts where you can.

3. **Tax drag is real but variable.** Tax drag is roughly 0.3-1.0% of annual return depending on dividend yield, turnover, and tax bracket. Low-cost broad market index funds have lower drag than actively managed funds.

4. **Roth doesn't always win.** Despite the "tax-free is best" intuition, Traditional wins when current marginal rate is meaningfully higher than expected retirement rate (and the tax savings get invested). For most middle-income earners, retirement rate is lower than current rate, slightly favoring Traditional. For young/low-bracket workers, Roth typically wins.

5. **Tax-free withdrawal flexibility is valuable.** Roth provides flexibility in retirement — withdrawals don't affect Medicare premiums, Social Security taxation, or other income-based programs. This optionality is hard to quantify but real.

Common mistakes to avoid

Investing in taxable before maxing tax-advantaged. Almost always sub-optimal. Capture employer match, max IRA, max 401(k), max HSA, then add taxable.
Wrong asset location. Holding bond funds in taxable accounts (taxed annually as ordinary income) while holding index funds in IRA — backwards from optimal.
Forgetting state tax in tax-equivalent calculations. State tax adds 0-13% to the marginal rate. Substantial impact on after-tax comparisons.
Treating dividends as "free" in taxable accounts. Qualified dividends are taxed annually at LTCG rates — meaningful tax drag over decades.
Choosing Roth based on intuition alone. Run the math with realistic current and retirement tax rates. The right answer varies by individual.
Ignoring withdrawal flexibility. Roth provides flexibility around Medicare premiums, Social Security taxation, ACA subsidies, and other income-tested programs. Worth real money even if pure math is closer.

Frequently Asked Questions

Sources & further reading

Saving and Investing — A Roadmap — U.S. Securities and Exchange Commission
Topic 409 — Capital Gains and Losses — U.S. Internal Revenue Service
Topic 404 — Dividends — U.S. Internal Revenue Service

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