How Brokerage Accounts are Taxed

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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 Roth IRAs, 401(k)s and HSAs) don’t provide you with much liquidity at all. Needless to say, this can be disadvantageous if you need cash quickly. That’s why taxable brokerage accounts could be a major attraction to you and your portfolio.

What is a taxable brokerage account?

Put simply, a brokerage account is a taxable account you open with a brokerage firm. After you fund your account, you can place orders to buy and sell. The broker charges you commissions and fees to fill your order. There are two types of accounts you can fund through a brokerage:

  • Cash accounts
  • Margin accounts

Why choose a taxable brokerage account?

We’ve already established that one of the advantages to a taxable brokerage account is that they’re more liquid than other types of tax-advantaged accounts. Other benefits to choosing a taxable brokerage account include:

  • You’re able to more money for retirement than your IRA contribution limit allows.
  • You plan to retire early, so you can place your money in a taxable brokerage account and take it out when you need it, rather than paying a penalty before age 59 ½.
  • You want to take on more risk with your money and the tax nip is worth it.
  • You might have short term needs (big purchases) that you’ll need to pay for prior to retirement.

How to set up a taxable brokerage account

The process to set up a brokerage account can be summarized in just a few steps. First, you’ll need to choose a brokerage firm. Benzinga can help you determine which will be best for you; check out The Best Online Stock Broker for Beginners. Here’s a quick look at our favorites below:

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Next, you’ll need to choose your funds. This can also be accomplished with Benzinga’s heavily-scoured research. Whether you’re after stocks, mutual funds or even forex, you’ll be able to see hundreds of options on Benzinga. Last, you’ll need to open your account, which will also include linking your brokerage account with your bank account. Next, execute your first buy order by typing in the name of the fund you want to purchase or searching for it and entering the amount you want to purchase. Choose your source as well (bank account). Finally, if you’d like to set up recurring contributions, you can easily do that with any online brokerage account.

Taxable brokerage accounts vs. tax-advantaged accounts

To understand what’s considered a taxable account and what’s considered a tax-advantaged account, Schwab has a nice breakdown and great advice as well:

Source: CharesSchwab.com
Source: CharlesSchwab.com

How brokerage accounts are taxed

Taxable brokerage accounts don’t offer any real tax benefits, which is the downside to these types of accounts. The upside, of course, is that you aren’t forced to keep your taxable accounts in a fund until you’re 59 ½. In a nutshell, whatever gains you make on a taxable brokerage account, you’ll have to pay taxes on those gains during that tax year. For example, if you’ve made $2,000 in a traditional brokerage account (not an IRA) and you’ve sold the fund in that particular brokerage account for a higher price than when you bought it, you’ll need to pay taxes on the $2,000 when you file your return. Short term and long-term capital gains and qualified and unqualified dividends are all taxed differently, and your actual tax rate will depend on your income level and on your filing status.

  • Short term capital gains refer to the sale of any asset owned for less than a year and is usually taxed at taxpayers’ top marginal tax rate, or your ordinary income tax rate.
  • Long-term capital gains refer to investments held more than a year, and tax rates are 0%, 15% or 20%, depending on income amount and filing status.
  • Qualified dividends are taxed at the capital gains tax rate.
  • Unqualified dividends are taxed at the income tax rate. See below.

Final thoughts

If you’re still struggling to decide which types of funds are most advantageous for you, it’s time to talk with an adviser about tax efficient strategies that can be artfully blended to produce your perfect portfolio. For most investors, it takes a little bit of everything to hit the investing sweet spot.

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