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When You Should Use a Taxable Brokerage Account

Taxable brokerage accounts don’t offer all of the tax incentives retirement accounts do, but they’re far more flexible.

If you expect to need any significant chunk of money before you retire, that makes them an essential part of your savings plans.

What is a Taxable Brokerage Account?

Taxable brokerage accounts are investment accounts where you can buy and sell various securities like stocks, bonds, and mutual funds.

Unlike retirement accounts, there are no specific tax advantages for contributions or withdrawals in a taxable brokerage account. You’ll pay taxes on any capital gains, dividends, or interest earned within the account.

These accounts offer flexibility in terms of accessing your money whenever you want, making them a popular choice for short to medium-term investments. It’s important to keep track of your gains and losses to accurately report them on your annual tax return.

Benefits of Taxable Brokerage Accounts

You can set up a taxable brokerage account with low-cost investing platforms like Betterment and M1 Finance. These accounts exist to help people invest for goals other than retirement.

While you won’t get a tax incentive for using one, they don’t have all of the rules and regulations retirement accounts have. That flexibility makes them worth using for a lot of situations.

Consider the following benefits.

1. No Income Requirements

There are no income requirements related to opening a taxable brokerage account. Also, while some brokerages have minimum deposit requirements, plenty have no minimums. All you need to get started is enough cash to buy your first investment.

2. No Contribution Limits

You can deposit as much as you want to your brokerage account, and you can make your deposits at any time. If you have a lot of extra cash, that makes it easy to invest as much of it as you’d like as quickly as you’d like.

3. Unlimited Investment Options

Typically, 401(k)s only offer a small selection of mutual funds. With a brokerage account, you can invest in anything: stocks, bonds, options, ETFs, futures, precious metals, commodities, forex, and more are all fair game for you. If you’re a sophisticated investor or want to play around with some nontraditional securities, a brokerage account lets you do that.

Before investing in exotic instruments, take the time to educate yourself. This list of the top forex trading books is a good start for budding forex investors, for example.

4. No Penalties for Early Withdrawals

Possibly the most crucial benefit of taxable brokerage accounts is that you can make a withdrawal whenever you like. All you have to do is sell enough investments to cover the amount you want to withdraw, then ask your brokerage company to send the funds to your checking account.

You will have to pay capital gains taxes if your investments gain value, but there are no withdrawal penalties to worry about.

5. No Mandatory Distributions

Taxable brokerage accounts don’t have required distributions. That means you can keep your money invested long past the time you turn 70 ½. That makes it easier to plan your taxes and leave your investments to grow for future generations.

When to Use a Taxable Brokerage Account

Taxable brokerage accounts are the right choice for several investing goals and situations.

When You’re Saving for Medium-Term Goals

Taxable brokerage accounts are ideal if you want to save for something but need to access the money before you reach retirement age. Whether you’re saving for a down payment on a house or funding a wedding, taxable brokerage accounts offer the growth and flexibility to help you reach your goal.

When You’ve Hit Contribution Limits

If you max out your 401(k) and IRA, you don’t have to stop saving. It just means you can’t contribute more money to those accounts. Taxable brokerage accounts have no contribution limits. You can use them to hold whatever extra cash you have that won’t fit within your retirement account contribution limits.

When You Need Flexibility

Everyone’s financial situation is different. You might want to keep some or all of your savings flexible in case you need to access it on short notice. You might want to retire early or have money available to help take care of a loved one in need. Penalty-free withdrawals provide the flexibility to make these things easy.

How to Reduce Taxes on Your Taxable Brokerage Account

Putting your money in a taxable account doesn’t mean you can’t take steps to reduce your tax bill. Following the right investing plan will reduce the amount you owe when you make withdrawals from your taxable brokerage account.

Hold Investments for at Least One Year

The IRS treats investments differently based on how long you hold the investment. The important cutoff date to remember is one year.

Any investments you sell within one year of buying are treated as short-term investments. You pay your regular income tax rate on any short-term capital gains you make from them.

If you hold an investment for at least one year before you sell it, you only have to pay the long-term capital gains rate.

2024 long-term capital gains tax rates :

SingleUp to $47,025$47,026 – $518,900Over $518,900
Married filing jointlyUp to $94,050$94,051 – $583,750Over $583,750
Married filing separatelyUp to $47,025$47,026 – $291,850Over $291,850
Head of householdUp to $63,000$63,001 – $551,350Over $551,350
Data from the Internal Revenue Service.

You’ll also pay the long-term capital gains tax rate on any qualified dividends you receive. These are dividends paid by U.S. or qualifying foreign companies on shares that you’ve held for a sufficient period of time before the ex-dividend date.

In other words, dividends are also taxed at a lower rate if you hold the dividend-paying investment for the long term, providing even more incentive to buy and hold.

Invest in Index Funds

If you invest in mutual funds, you’ll have to pay taxes based on the actions the fund managers take on your behalf. If the fund realizes capital gains, you will pay those taxes. The cost can add up quickly if you’ve invested in an actively managed fund that makes lots of transactions.

Index funds are more hands-off investments. They seek to emulate a specific stock index rather than outperform the market. That means managers make far fewer transactions, which in turn means investors realize fewer capital gains. The gains they realize are typically long-term, so the IRS taxes them at a lower rate than short-term gains.

You’ll still pay taxes when you sell your shares, but reducing the taxes you pay while your money is in the fund can increase your investments’ growth.

Invest in Tax-Advantaged Federal or Municipal Bonds

It’s possible to take advantage of certain tax benefits even if you hold the tax-advantaged investments in a taxable account.

Municipal bonds are bonds offered by local governments. They’re usually used to fund specific projects like improving a school or roadway. The interest you earn from municipal bonds is exempt from federal taxes. Most states also exempt you from taxes if the bond is from a city or town in the same state.

Federal savings bonds also offer some tax incentives. For example, bond interest is only taxable at the federal level; they’re exempt from state and local taxes.

You can even avoid the federal taxes on savings bonds if you use the proceeds to pay for qualified educational expenses, making them completely tax-free investments. For singles and heads of household, this tax incentive is only available if your Modified Gross Annual Income is less than $82,350.

After that amount, the tax incentive starts to phase out until you make $97,350 each year, at which point the incentive ends. If you’re married, the phaseout starts at $123,550 and you can no longer receive the incentive if you make more than $153,550.

If you are married filing separately, you’re not eligible for this tax incentive.

Final Word

Retirement accounts are fantastic for their intended goal: saving for retirement. But they’re not the be-all and end-all when it comes to investing. Taxable brokerage accounts are the right tool to use if you need more flexibility or have financial goals you want to reach before you retire.

Grant Sabatier is a co-founder and CEO of MMG Media Group, which owns Grant is also the Creator of Millennial Money and Author of the International Bestseller Financial Freedom (Penguin Random House), which has been translated into fifteen languages. Dubbed the “Millennial Millionaire” by CNBC, Grant went from $2.26 to a millionaire in 5 years, reaching financial independence at the age of 30. Grant has been featured in The New York Times, The Washington Post, NPR, BBC, CNBC, Forbes, Business Insider, Money Magazine, The Wall Street Journal, Marketwatch, the Rachael Ray Show, and many others. He cares passionately about sharing his story to inspire others to build a life they love, reminding everyone that time is more valuable than money, and building cool stuff.

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