When You Should Use a Taxable Brokerage Account - SmartAsset

A taxable brokerage account that allows you to buy and sell a wide range of securities, such as stocks, bonds, mutual funds and exchange-traded funds (ETFs). Unlike contributions to a traditional IRA or a 401(k), contributions to a taxable brokerage account are made with after-tax dollars, meaning that investors do not receive any tax benefits from them. However, taxable brokerage accounts are still valuable for investors. Here’s when you might want to use these accounts. If you need more personalized advice, consider working with a financial advisor.

Understanding Taxable Brokerage Accounts

A taxable brokerage account is a type of investment account that allows investors to use after-tax dollars to buy various securities, such as stocks, bonds, mutual funds and ETFs. Because you buy investments with after-tax dollars in these accounts, they don’t receive the same benefits as tax-advantaged accounts like a 401(k) or IRA.

As a result, taxable brokerage accounts may be subject to capital gains when investors sell securities within a taxable brokerage account. The amount of taxes owed depends on several factors, including the length of time the securities were held and the investor’s income tax bracket. Additionally, any dividends earned within a taxable brokerage account are subject to income taxes.

Despite these downsides, taxable accounts have some benefits. For example, they tend to have greater flexibility than tax-advantaged accounts. This is because you can access your money at any time without incurring a penalty, as you often might with a 401(k) or IRA. Taxable accounts can have a wider range of investment options compared to mutual funds in a 401(k).

When to Use a Taxable Brokerage Account

While tax-advantaged accounts like IRAs and 401(k)s are commonly used for long-term retirement savings, there are several situations where a taxable brokerage account may be the better choice. Here are some examples of times when you might use a taxable brokerage account:

You have short-term investment goals: If you have short-term investment goals, such as saving for a down payment on a home or purchasing a car, a taxable brokerage account may be a good option. Since there are no penalties for early withdrawals, investors have greater flexibility in accessing their money without restrictions.
You want to diversify your retirement portfolio: If you want to diversify your retirement portfolio, you may want to consider using a taxable brokerage account. Also, there are contribution limits for tax-advantaged accounts like IRAs and 401(k)s, but these limits don’t apply to taxable brokerage accounts.
You need liquidity: If you need access to your money soon, a taxable brokerage account may be a good option. Unlike tax-advantaged accounts like IRAs and 401(k)s, there are no restrictions on when or how much money investors can withdraw from a taxable brokerage account.
When planning your estate: Investors who are concerned about estate planning may want to consider using a taxable brokerage account. Since tax-advantaged accounts like IRAs and 401(k)s have required minimum distributions (RMDs) that must be taken after a certain age, these accounts may not be the best choice for individuals who want to leave money to their heirs. In contrast, a taxable brokerage account can be passed down to heirs without any RMDs, making it a good choice for estate planning purposes.

Tax Considerations

There are several tax considerations to keep in mind before you consider putting money in a taxable brokerage account. The most obvious is capital gains taxes, which may result in taxes if you sell securities for a profit. The amount of taxes owed depends on several factors, including the length of time the securities were held and the investor’s income tax bracket.

Another tax consideration for taxable brokerage accounts is dividend income taxes. When investors earn dividends from securities within a taxable brokerage account, they must pay income taxes on those dividends. The tax rate depends on the investor’s income tax bracket.

One of the most important tax considerations when using a taxable brokerage account is tax-efficient investing. This involves making investment decisions that minimize taxes and maximize after-tax investment returns. For example, investors may choose to invest in tax-efficient funds or use tax-loss harvesting strategies to minimize taxes. However, you should always meet with a financial advisor before making any major investment decisions.

Strategies for Maximizing Benefits of Taxable Brokerage Accounts

Although taxable brokerage accounts are not tax-advantaged, there are still some ways to minimize your taxes in these accounts. One strategy is to buy tax-advantaged investments. These might include municipal bonds or certain types of funds that have tax advantages. Municipal bonds, for example, are typically exempt from federal taxes and sometimes state taxes as well. By investing in tax-advantaged investments, investors can minimize the amount of taxes owed on their investments.

Another strategy for maximizing the benefits of a taxable brokerage account is tax-loss harvesting. This involves selling investments that have lost value to offset gains from other securities and reduce your tax bill. Tax-loss harvesting can be a useful strategy for minimizing taxes, but there are certain rules and limitations you must follow when tax-loss harvesting.

As always, consult a financial advisor before you settle on an overall investment strategy. Not only can a financial advisor help you make the best investment decisions overall, but they can also help you make smart decisions from a tax perspective.

The Bottom Line

Generally, most investors should prioritize accounts like IRAs and 401(k)s over taxable brokerage accounts, which don’t have as many tax advantages. However, there are some reasons you may want to use a taxable brokerage account, such as when you have short-term investment goals or your investment to have high liquidity. Nevertheless, these accounts can result in a larger tax liability than retirement accounts, so it’s best to consult a tax professional before you decide how to allocate your money.

Tips for Retirement

A financial advisor can guide you through major financial decisions, like determining your investing strategy. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Deciding how to invest can be a challenge, especially when you don’t know how much your money will grow over time. SmartAsset’s investment calculator can help you estimate how much your money will grow to help you decide which type of investment is right for you.