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A brokerage account is a financial vehicle that lets you invest in assets like stocks, bonds, mutual funds, exchange-traded funds (ETFs) and more. They're sometimes called taxable accounts because they don't offer the same tax advantages that are common with retirement accounts. But brokerage accounts are less restrictive than traditional retirement accounts. There are no contribution limits, and you can tap your funds whenever you like without penalty (though you'll likely be taxed on investment gains).
A taxable brokerage account works a little differently than other accounts, but it can be a viable way to grow your wealth over time.
How Brokerage Accounts Work
Like other investment accounts, a taxable brokerage account allows you to invest in all kinds of securities. These include high-risk assets as well as more stable securities. These flexible investment tools can help you make progress toward both short- and long-term savings goals. You might use a taxable brokerage account to save for:
- Expenses for your children (college, weddings, cars and so on)
- Home renovations
- Funding a business
- Any other big-ticket expenses on the horizon
There are two main types of brokerage accounts: cash accounts and margin accounts.
With a cash account, you'll pay the full amount for whatever securities you purchase. Margin accounts, on the other hand, allow you to borrow money from your brokerage firm to buy securities. The assets in your portfolio then act as the loan's collateral.
Buying on margin can trigger additional investment costs and increased risk. If your assets decline in value, the firm might sell off other securities in your account to cover the difference.
How Brokerage Accounts Differ From Other Accounts
Here are some of the ways a brokerage account stands apart from other accounts:
- It's an investment account. After funding your account, you can make investment decisions yourself or give your broker the authority to do so on your behalf. If you go with the latter, they'll use your goals to guide the way they buy and sell different securities within your brokerage account.
- It isn't meant for everyday transactions. Unlike a checking account, brokerage accounts are built to house—and grow—a portion of your wealth. They aren't set up for day-to-day transactions. However, you can withdraw cash from a brokerage account at any time by transferring it to your checking account.
- It isn't the same as a savings account. A savings account is a holding place for your cash reserves. Many pay out an annual percentage yield (APY), which essentially rewards you for parking your money there. A brokerage account allows you to buy and sell different assets on a rolling basis, though you may earn interest on uninvested cash.
Brokerage Accounts vs. Bank Accounts
Below are a couple of other important ways a brokerage account is different from a bank account:
- Liquidity: Brokerage accounts are relatively liquid. You can withdraw cash at any time for any reason without penalty. If you need more, you also have the option to sell securities, though doing so could result in a loss. With a savings account, you're limited to the cash you have in the account.
- Insurance: Checking and savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC), and are covered up to $250,000 per account holder per account. However, the FDIC does not insure investment accounts. Instead, most brokerage firms offer Securities Investor Protection Corporation (SIPC) insurance. This provides up to $500,000 of protection, half of which can be used for cash.
Brokerage Accounts vs. Retirement Accounts
Retirement accounts are investment accounts that typically offer tax benefits to incentivize long-term saving. But there are some disadvantages. If you have money in a tax-deferred retirement account like a 401(k) or traditional IRA, you must begin taking required minimum distributions (RMDs) at age 72. There are also rules around when you can withdraw your funds. (More on this below.)
A regular brokerage account offers more control and flexibility, though fewer tax advantages. You'll likely be taxed on earnings during the year they're realized (not when you make withdrawals). This includes income generated by investment gains, stock dividends and interest. You'll also miss out on the tax breaks available through certain retirement accounts, which can be significant. Here's a rundown of how popular retirement accounts are structured:
A 401(k) is an employer-sponsored retirement plan that's funded with pretax contributions. The money you put in is tax-deductible, which reduces your taxable income during your working years. Your employer might even match some of your contributions. If this is the case, it's wise to exhaust this option before investing through a brokerage account.
Your 401(k) withdrawals are taxed as ordinary income, and you'll likely be hit with a 10% penalty if you tap your funds prior to age 59½. In 2022, you can contribute up to $20,500 to your 401(k). Folks who are 50 and over can kick in an extra $6,500 for a total of $27,000.
A traditional IRA is a retirement account you can open on your own through a broker. Contributions may be tax-deductible, and distributions count as taxable income. Early withdrawal penalties also apply. In 2022, you can contribute up to $6,000 across all your individual retirement accounts; $7,000 if you're 50 or older.
Roth IRAs are funded with after-tax dollars. While you won't get the tax break on your contributions, your distributions in retirement are tax-free. In fact, you can withdraw your cash whenever you like, though tapping investment earnings prior to age 59½ may trigger a tax liability. You also have to meet IRS income requirements to contribute to a Roth IRA.
How to Choose a Broker
You'll need to partner with a broker to open a brokerage account. E-Trade, Fidelity Investments and TD Ameritrade are popular online brokerages. They each allow you to buy, sell and manage investments on your own. This usually involves a higher level of engagement and research.
If you prefer a more hands-off approach, a robo-advisor may be a better fit. These automated advisors rely on algorithms shaped by your risk tolerance, age and financial goals. Fees are usually on the lower side as well. Alternatively, you could work with a licensed financial advisor who can manage your investments for you. You'll get personalized guidance, but it can come at a premium.
Consider the following factors when looking for a broker:
- Do they have good reviews?
- Will you be managing your investments yourself or with the help of an advisor?
- Are there any fees for buying or selling investments?
- Are there fees for account maintenance?
- What happens to uninvested cash in your brokerage account? (Some firms automatically sweep it into other investments or an external bank account.)
How to Open a Brokerage Account
Once you find a broker you like, be prepared to provide basic personal and financial information to open your account. According to the U.S. Securities and Exchange Commission, this typically includes:
- Contact information (address, phone number and email)
- Social Security number
- Date of birth
- Government-issued identification like a driver's license or passport
- Employment information
- Annual income and net worth
- Investment goals
- Risk tolerance
- Investment timeline
- Liquidity needs
- Other investments
If you're opening a cash account, you'll need to initiate a funds transfer to get rolling. This usually involves linking a bank account so you can fund your new brokerage account.
The Bottom Line
A taxable brokerage account is one way to invest in securities like stocks, bonds, ETFs, mutual funds and more. It doesn't offer the same tax breaks as retirement accounts, but it can still be a great way to save for short- and long-term financial goals.
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