If you've ever pulled money from a Transfer on Death (TOD) brokerage account and wondered why your tax bill looked the way it did, you're not alone. Questions about non-qualified account taxes are some of the most common ones we hear, so let's walk through how it actually works.
What makes an account "non-qualified"?
A non-qualified account is simply a regular investment account that doesn't carry the tax advantages of an IRA, 401(k), or other retirement plan. There's no tax deduction when you contribute, and there's no penalty for withdrawing at any age. A TOD brokerage account falls into this category. The tradeoff for that flexibility is that growth in the account can be taxable along the way, and money you take out isn't automatically tax-free.
What actually triggers a tax bill in a brokerage account?
1. Selling an investment for a gain. When you sell a stock, fund, or other holding inside the account for more than you paid for it, that's a capital gain. It gets taxed differently depending on how long you held it:
- Held one year or less: taxed as a short-term gain, at your ordinary income tax rate.
- Held more than one year: taxed as a long-term gain, generally at 0%, 15%, or 20%, depending on your income.
Simply withdrawing cash that's already sitting in the account, with no sale involved, doesn't create a taxable event on its own. The tax comes from the sale that generated the gain, not from the act of moving cash to your bank account.
2. Dividends and interest. Even if you never sell a thing, a non-qualified account can generate a 1099 each year for dividends, interest, or capital gains distributions from mutual funds. These are taxable in the year they're paid, whether or not you reinvest them.
How is cost basis calculated?
Your gain (or loss) is calculated as:
Sale price minus cost basis = gain or loss
Cost basis is generally what was originally paid for the investment, adjusted for things like reinvested dividends or stock splits. Your custodian typically tracks this and reports it on your 1099-B when a sale occurs, which makes it easier to see exactly what's taxable.
Do you owe taxes on an inherited TOD account?
This is where it gets more favorable. If a TOD account passed to a beneficiary due to the original owner's death, the cost basis on the inherited assets is typically "stepped up" to the value on the date of death. That means:
- Any growth that happened during the original owner's lifetime is not taxed to the beneficiary.
- The beneficiary's cost basis becomes the value on the date of death, not what the original owner paid.
- If the beneficiary sells shortly after inheriting, there may be little or no gain to report at all.
This step-up is one of the more meaningful tax benefits of holding appreciated assets in a taxable account through the end of life, rather than gifting them during life.
Ways to manage taxes on a non-qualified account
Because taxes in a non-qualified account are driven by what you sell and when, there's actually a fair amount of room to manage the impact with some intentional planning.
Selling losing positions on purpose (tax loss harvesting). If a position is currently worth less than what was paid for it, selling it locks in that loss for tax purposes. The proceeds can be reinvested in something similar to keep the portfolio's overall mix intact. That realized loss can offset gains elsewhere in the account, and if losses run higher than gains in a given year, up to $3,000 can offset ordinary income too, with any leftover carried into future years. One rule to know: buying back the same or a very similar investment within 30 days before or after the sale can disallow the loss, so timing matters.
Choosing which shares to sell. When a position was built up over time through several purchases, each purchase can have a different cost basis. Rather than automatically selling the oldest shares first, it's often possible to choose which specific shares to sell, whether that's the ones with the smallest gain to minimize taxes, or a different batch entirely depending on the goal.
Spreading gains out to stay in a lower tax bracket. Long-term capital gains have their own bracket structure, and in lower-income years, such as early retirement, some gains can potentially be realized at a 0% tax rate. Spreading sales across a few years, rather than selling everything at once, can help keep gains taxed at a lower rate.
Rebalancing without selling. Instead of selling appreciated positions to bring a diversified portfolio back in line, new contributions or reinvested dividends can be directed toward the parts of the portfolio that are underweighted. This shifts the balance without triggering a taxable sale.
Pairing gains and losses in the same year. Since gains and losses in a non-qualified account offset each other for tax purposes, a year where a gain is being realized from one position can be a good time to review the rest of the portfolio for any other positions worth trimming as well, so the net tax impact is smaller.
Used together, these strategies don't eliminate taxes on a non-qualified account, but they can meaningfully reduce what shows up on a given year's return.
The bottom line
With a non-qualified account, taxes are triggered by selling investments at a gain or by receiving dividends and interest, not simply by withdrawing money. For inherited TOD accounts, the step-up in basis often means the tax picture is more favorable than people expect, and for accounts you're actively managing, a few intentional strategies can help keep the tax bill smaller.
Every situation is different, and cost basis details can get more complex depending on how the account was invested. If you have questions about your specific account, a recent inheritance, or want to talk through Roth conversions, reach out and we can walk through it together.