Tax drag is the invisible cost that taxes impose on investment returns in taxable accounts. Every year, dividends and realized gains get taxed, reducing the compounding base. Over decades, this can cost hundreds of thousands of dollars compared to tax-advantaged alternatives. This simulator puts a precise dollar figure on that cost across all three major account types.
Investment Parameters
Typical index fund: ~1.5%. REIT: 3-5%.
Index ETF: ~3-5%. Active fund: 30-100%.
Account Growth: Taxable vs Tax-Deferred vs Tax-Free
Year-by-Year Detail
| Year | Taxable | Traditional IRA | Roth IRA |
|---|
How to Use the Tax Drag Simulator
Every dollar you invest in a taxable brokerage account faces a silent headwind: annual taxes on dividends and realized gains. The tax drag simulator quantifies this headwind precisely, showing how much of your wealth is diverted to taxes each year versus what you'd accumulate in a Roth IRA (tax-free forever) or Traditional IRA (tax-deferred until withdrawal).
Step 1: Enter Your Investment Amount
Start with your initial investment and annual contribution. These same amounts are modeled identically across all three account types — the only difference is how taxes are applied. For a $100,000 initial investment and $10,000/year contribution at 8% return and 22% income tax rate, the 30-year difference between taxable and Roth is typically $200,000–$350,000 depending on dividend yield and turnover.
Step 2: Set Dividend Yield and Turnover
These two variables determine most of your tax drag. Dividend yield is the annual income distribution from your holdings. A broad index fund like VTI yields about 1.3-1.5%; dividend-focused funds yield 2-4%; REITs yield 3-6%. Capital gains turnover is what percentage of your portfolio gets "realized" (sold and repurchased) each year — generating taxable gains. A passive index ETF has 3-5% turnover; an active fund may have 50-100%.
Step 3: Select Your Tax Rates
The income tax rate applies to ordinary dividends (like REIT distributions, money market interest, and bond coupons). The capital gains rate applies to qualified dividends (most stock dividends) and long-term realized gains. Most middle-income investors use 15% capital gains rate. High earners (above ~$553K single in 2026) pay 20% on capital gains, plus a 3.8% NIIT surcharge not modeled here.
Step 4: Interpreting the Results
The chart shows three diverging lines. The Roth IRA line represents your maximum possible outcome — no tax ever on growth. The Traditional IRA line is close to Roth (since growth is also tax-deferred) but you'll eventually pay income tax on withdrawals not shown here. The taxable account line falls below both. The "Annual Tax Drag $" column in the table shows the exact dollar amount going to taxes each year in the taxable account — watch how it compounds as the account grows.
The Takeaway: Max Tax-Advantaged Accounts First
The simulation makes the rule concrete: always fill tax-advantaged accounts (401k, IRA, HSA) before investing in taxable accounts. For 2026, the limits are $23,500 for 401(k) contributions, $7,000 for IRA contributions ($8,000 if 50+), and $4,300/$8,550 for HSA (individual/family). Only after these are maxed should you invest in a taxable brokerage. When you do invest in taxable, favor low-yield, low-turnover index ETFs to minimize tax drag.
FAQ
What is tax drag in investing?
Tax drag is the reduction in investment returns caused by annual taxes on dividends, interest, and realized capital gains in a taxable brokerage account. A taxable account paying 2% in dividends at a 22% income tax rate loses 0.44% per year to tax drag — even before considering capital gains taxes on growth. Over 30 years on a $100,000 initial investment, this can cost $50,000–$150,000 compared to tax-advantaged alternatives.
How does a Roth IRA eliminate tax drag?
A Roth IRA eliminates tax drag completely — contributions are made with after-tax dollars, but all growth and qualified withdrawals are tax-free. Dividends, capital gains, and interest compound without any annual tax haircut. For a $100,000 investment growing at 8% for 30 years, the difference between a Roth (zero tax) and a 22% income tax rate taxable account can exceed $200,000.
Is a traditional IRA better than a taxable account for investing?
Yes, a traditional IRA is almost always better than a taxable account for long-term investing. Contributions are pre-tax (immediate tax deduction), growth is tax-deferred (no annual dividend or capital gains tax), and you only pay income tax on withdrawals. The tax deferral alone adds significant value. The only case where taxable beats traditional is if your retirement tax rate is substantially higher than your current rate — rare for most people.
What inputs should I use for dividend yield and turnover?
For a broad market index fund (e.g., S&P 500 ETF): dividend yield 1.3-1.5%, turnover 3-5% (index funds have very low turnover). For an actively managed fund: dividend yield 1-2%, turnover 50-100%. For a stock-heavy portfolio: dividend yield 2-3%, turnover 10-20%. Lower turnover and lower dividend yield reduce tax drag significantly — this is why broad index ETFs like VTI are more tax-efficient than actively managed mutual funds.
Is this tax drag simulator free to use?
Yes, completely free with no signup required. All calculations run in your browser — your investment data is never sent to any server.
Why does dividend yield increase tax drag so much?
Qualified dividends are taxed at 0%, 15%, or 20% capital gains rates. Ordinary dividends (REITs, money market, some international stocks) are taxed as income at 10-37%. Even at 15% qualified dividend rate, a 2% yield means 0.3% annual drag. Over 30 years with 8% gross return, this reduces a $100,000 portfolio to about $890,000 vs $1,006,000 with no dividend tax — a $116,000 difference from dividends alone.
Does this account for state income taxes?
No — this simulator uses federal rates only. State income taxes on dividends and capital gains vary: nine states have no income tax, while California taxes all capital gains and dividends as ordinary income (up to 13.3%). For a more conservative estimate, add your state rate to the federal rate when selecting your marginal income tax rate.