Brokerage accounts can be a great solution.
We recommend saving 20-25% towards retirement. For many high-income earners, saving just to retirement accounts (401(k)s, Roth IRAs, HSAs, etc.) does not offer enough room to reach their savings goals.
After saving the maximum allowed to tax-advantaged retirement accounts, hyper-accumulating into a brokerage account is Step 7 in the Financial Order of Operations. While a brokerage account is not tax-advantaged, this taxable asset can play a key factor in your financial plan, allowing for easier access to withdrawals and tax-rate manipulation in retirement.
Why a brokerage account?
Brokerage accounts offer a few benefits that aren’t available in retirement plans. First, there are no contribution, income, or eligibility limits to contribute to a brokerage account, opening up this opportunity to almost everyone.
Need access to your savings pre-retirement age (59 1/2 in most cases), but still want your accounts to be able to grow with the market? Brokerage assets can be withdrawn at any time. For those looking to retire early, this can be a really important savings “bucket” to pull from while unable to access retirement account assets. This can also be a great bucket to save and invest for long-term (more than 5 years away) goals.
Brokerage accounts are taxed differently than any other retirement accounts. Pre-tax & traditional retirement account withdrawals are taxed as ordinary income at marginal (your highest) tax rates. Roth retirement account withdrawals are not taxed (they were taxed before you contributed). On the other hand, brokerage assets are not tax-advantaged. Income received from interest or dividends in the account are considered ordinary income as the account is growing. There is an advantage, though, in capital gains taxation. Any realized (sold) gains from a brokerage account account are taxed according to a different schedule. Assets that are held for a year or less are considered short term capital gains, and are taxed as ordinary income. Assets that are held for a year and a day (or longer) are considered long-term capital gains, and are taxed at either 0%, 15%, or 20%, depending on the owner’s income. These long-term capital gains rates are lower than marginal income tax rates, allowing for reduced tax liability for the same amount of income. This can be a great planning opportunity if the account is used for retirement income. Finally, another advantage of brokerage accounts is the ability to tax-loss harvest. Positions that are sold at a loss can be used to offset account gains, and can even be carried forward to future years.
Where do I get a brokerage account?
The important things to look for within these accounts are the fees the account will charge, what investments you will have access to (diversity of funds, expense ratios within funds, fees charged for transacting within those funds, etc.), and any requirements of the account (account minimums, advisory products tied to the account, etc.).
How do I invest a brokerage account?
Since brokerage accounts are not tax-advantaged, it is important to be mindful of how the account is invested and how that will affect your tax situation. Dividends and interest produced within a brokerage are taxed at ordinary income rates. For this reason, it may be worth considering investing in low-cost index funds that produce little income, or even municipal bond funds within a brokerage account.
One thing Brian likes to say is “Don’t let the tax tail to wag the investment dog”. It is important to always keep your risk tolerance and goals (as opposed to your tax bill) at the forefront of your mind when making investment decisions.
Check out this Money Guy content about investing in a brokerage account: