How Brokerage Accounts are Taxed

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Contributor, Benzinga
February 6, 2024
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For maximum splash, as you try to lower your tax bite, you might choose to invest from a pool of tax-advantaged accounts. However, many of these types of accounts (think IRAs, 401(k)s and HSAs) don’t provide you with much liquidity at all. This feature can be disadvantageous if you need cash quickly. 

Maximizing tax-advantaged accounts can help you save more and optimize financial growth when building long-term wealth. But a standard brokerage account can be a good choice if you've maxed out tax-advantaged accounts or need the funds sooner than retirement age. The tax implications for taxable brokerage accounts depend on your income and total capital gains. Read on to understand how brokerage accounts are taxed and what it may mean for your situation to potentially save more.  

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What is a Taxable Brokerage Account?

A taxable brokerage account is an investment account that doesn't receive favorable tax treatment like IRAs or 401(k)s. While tax-advantaged accounts allow your investments to grow tax-deferred or tax-free, you must pay taxes on all capital gains from a taxable brokerage account each year. 

Taxable Brokerage Accounts vs. Tax-Advantaged Accounts

You can choose from various types of tax-advantaged retirement accounts, including a 401(k), an individual retirement account (IRA) or a Roth IRA. 

In the case of a traditional 401(k) or a traditional IRA, you don't pay taxes on the funds deposited. Instead, you deduct the deposited amount from your taxable income. Then, you'll need to pay taxes when you withdraw funds and take the required minimum distributions after 72 (73 if you reach age 72 after Dec. 31, 2022). There are penalties for withdrawals before age 59 ½. With a Roth IRA or 401(k) account, you pay taxes on funds deposited into the account but don't need to pay taxes when funds are withdrawn. 

In contrast to these tax-advantaged accounts, you'll pay taxes on all funds deposited into a brokerage account and on capital gains each year.  

How Are Brokerage Accounts Taxed?

Brokerage accounts are taxed based on how long you hold investments in the account. When you buy stocks, bonds, exchange-traded funds (ETFs), mutual funds or other investment vehicles and sell them, the capital gains are taxed. Whether you'll pay short-term or long-term capital gains tax depends on how long you hold the investments. Read on to understand brokerage account tax rates. 

How Capital Gains Are Taxed

The gain of value on any asset is called capital gains. If you buy and sell a stock in less than a year, you usually need to pay short-term capital gains tax. If you hold the stock for over a year, you may qualify for long-term capital gains tax. Short-term capital gains are taxed at your regular income tax rate. Long-term capital gains are taxed at a graduated rate of 0%, 15% or 20%. 

How Dividends Are Taxed

Dividends are also taxed at varying rates. Nonqualified dividends are taxed as income at your regular income rate up to 37%. Qualified dividends are taxed at 0%, 15% or 20%, depending on your taxable income and filing status.

Nonqualified dividends, also called ordinary dividends, are any dividends that don't meet IRS requirements for a lower tax rate. Instead, they are taxed at your ordinary income rate.

Qualified dividends meet certain IRS criteria. To qualify, the dividend must meet three main criteria:

  1. Type of company: Paid by a U.S. corporation or qualifying foreign entity. 
  2. Type of dividend: Considered a dividend by IRS criteria and are not annual distributions from a credit union, premiums paid back by an insurance company or dividends paid from tax-exempt organizations or co-ops. 
  3. Length of time holding investment: You must hold the security for "long enough." Usually, that means you must hold it for at least 61 days during a 121-day period beginning 60 days before the ex-dividend date. 

How Interest Income Is Taxed

Interest income is taxed at the same rate as ordinary income tax, ranging from 0% to 37%, depending on your income tax rate.  

Tax rateSingleHead of householdMarried filing jointly or qualifying widowMarried filing separately
10%$0 to $11,600Up to $16,550$0 to $23,200$0 to $11,600
12%$11,601 to $47,150$16,551 to $63,100$23,201 to $94,300$11,601 to $47,150
22%$47,151 to $100,525$63,101 to $100,500$94,301 to $201,050$47,151 to $100,525
24%$100,526 to $191,950$100,501 to $191,950$201,051 to $383,900$100,526 to $191,950
32%$191,951 to $243,725$191,951 to $243,700$383,901 to $487,450$191,951 to $243,725
35%$243,726 to $609,350$243,701 to $609,350$487,451 to $731,200$243,726 to $365,600
37%$609,350 or more$609,350 or more$731,201 or more$365,600 or more
Source: IRS

How Retirement Accounts Are Taxed

A taxable brokerage account holding funds for retirement is taxed according to standard IRS capital gains tax procedures for capital gains, interest and dividends. On the other hand, tax-advantaged retirement accounts are taxed according to specific tax-advantaged rules. 

Pros and Cons of Taxable Brokerage Accounts

Taxable brokerage accounts offer significant advantages with a few major drawbacks. Here are the pros and cons of taxable brokerage accounts: 

Pros:

  • Simple to open
  • Often very low fees
  • Can sell securities and access funds at any time
  • Secure

Cons:

  • Pay taxes on all earnings each year, including dividends, interest and capital gains 

How to Open a Taxable Brokerage Account

The steps to open a brokerage account are relatively simple, but you'll want to shop around to get the best available offers. It usually only takes a few minutes to open the brokerage account, assuming you have the necessary funds for the initial deposit. You'll be asked for personal information during account setup. Here are the steps to take. 

1. Choose a Brokerage Firm

Choosing a brokerage firm is the most important step in opening a taxable brokerage account as it can affect both the available securities and the fees you'll pay. If you're planning to open a managed account, consider asking friends or colleagues and reading online reviews. For online brokers and robo-advisors, consider how user-friendly the website or app is and what added features they have to offer. 

Check fees, fund selection and available securities for all brokerage firms. Look at the minimum account opening requirements. Consider whether you need human support and the available support. You can compare fees, support, websites and fund selections of at least three different brokerages and read the reviews of other users to get an idea of what to expect. 

2. Choose the Type of Brokerage Account You Prefer

The different types of brokerage accounts available include full-service brokerage accounts as well as online brokerage accounts, cash brokerage accounts and margin brokerage accounts. 

  • Full-service brokerage accounts allow investors to get professional investment advice or support with their financial planning. 
  • Online brokerage accounts are a simple solution to select your own investments and execute trades via a website or mobile app.
  • Cash brokerage accounts mean the investor must pay in full for securities purchased and may be online or at physical brokerages.
  • Margin brokerage accounts in which the broker-dealer lends the investor cash to purchase securities with the account as collateral.

3. Open the Account

Once you decide on the type of account you want to open, you will need to provide personal information to the brokerage, such as:

  • Your Social Security number (SSN) or a Tax Identification Number (ITIN)
  • Government-issued ID such as a driver’s license or passport
  • Employment status information
  • Information about your annual income and net worth
  • An overview of your investment objectives

4. Fund the Account   

To fund the account, you can use various transfer methods such as electronic funds transfer. You can link a bank account and transfer money directly. You could also wire transfer money, deposit a check or transfer investments from another broker.

5. Choose Your Investments

When investing in your brokerage account, consider a risk-balanced diversified investment approach with investments across asset classes. Different types of investments to consider include stocks, bonds, mutual funds, ETFs, forex, real estate investment trusts (REITs) or cryptocurrency. 

Tips to Minimize Taxes on Brokerage Accounts

To reduce taxes on brokerage accounts use the following strategies:

  • Maximize investments in tax-advantaged accounts like a 401(k), IRA, Roth IRA or HSA.
  • Buy and hold securities for over a year to take advantage of lower long-term capital gains tax rates
  • Donate some portion of proceeds to 501(c)(3) charities to do good and share your good fortune, with a tax deduction
  • Choose passive funds like index funds and ETFs
  • Earn qualified dividends to save more 
  • Choose tax-efficient bonds like municipal bonds or series I bonds

Should You Open a Taxable Brokerage Account?

Taxable brokerage accounts offer a solution to grow wealth in the long and short term. Whether you've already maxed out tax-advantaged accounts or need more access to money you plan to use before retirement, a brokerage account can make sense. Learn more about comparing online brokers and find the best online trading platforms, the best stock brokers for beginners or the best high-return investments as part of a risk-balanced portfolio

Frequently Asked Questions

Q

Is it worth having a taxable brokerage account?

A

Yes, having a taxable brokerage account is worth it if you need to save more for retirement or have already maxed out tax-advantaged retirement accounts. Taxable brokerage accounts are also worth it if you need to access invested funds before retirement.

 

Q

How do I know if I have a taxable brokerage account?

A

You can check with your brokerage to understand the type of investment accounts you have, including tax-advantaged accounts or brokerage accounts.

 

Q

How do I withdraw from my taxable brokerage account?

A

You can withdraw money from your brokerage account with a bank account transfer, a wire transfer or by requesting a check.

 

Q

Are brokerage accounts automatically taxed?

A

Brokerage accounts are not automatically taxed, although you must pay capital gains tax on all earnings from realized capital gains, dividends or interest. You must pay taxes on the money in the year it’s received, even if you opt to reinvest it. 

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