A brokerage account can be especially meaningful in your 30s and 40s. Between the added flexibility and tax planning opportunities, including this account along with your retirement accounts is usually worthwhile. Learn about four ways that a taxable brokerage account can elevate your finances and how it’s different from retirement accounts. And listen to the end to understand how NOT to use this account (to avoid unnecessary taxes).
See the transcript below the video if you prefer to read!
Do you have as much flexibility as you could have with your investments? One of the most underappreciated accounts is a taxable brokerage account, which is simply a general account where you can invest your money. It doesn’t have special tax treatment designed specifically for retirement savings, but it does add tax planning opportunities and flexibility. When you’re in your 30s and 40s, flexibility is incredibly valuable because your plans may change over time. Here are four reasons adding a taxable brokerage account to your financial plan may be helpful.
Access Your Money Without Restrictions
Number one, you can take money out of a brokerage account any time you want. Now, of course, when we invest we’re investing for the long term. But it’s nice to have an account where money can be taken out with no penalties. With retirement accounts, if money is taken out before age 59 1/2, there can be penalties. There are some exceptions to the penalties, but planning around those exceptions isn’t always optimal.
A taxable brokerage account adds a lot of flexibility because there are no limitations and no restrictions on when money can be taken out. The money could be used for early retirement. Or you may never want to retire, but maybe you want to switch careers and the new career would offer less income. This could serve to bridge the gap for your income. Or it could be used for college funding. There are a lot of different options we can incorporate into your financial plan and a brokerage account adds a lot of flexibility for those different options.
Save To A Brokerage Account Without Limits
Number two, you can save as much as you want to a brokerage account. With retirement accounts, contribution limits apply each year. So you may not be able to save as much as you want or need to, depending on your financial plan and the future that you want. With a brokerage account, there are no limitations or restrictions with how much you can save. You can save from bonuses, stock options, or regular monthly contributions. And all of that money can be moved into this account and invested for your future without limitation.
Reduce Your Taxes With Long-Term Capital Gains
Number three, long term capital gains rates apply to this account. I’ll briefly explain the difference between retirement accounts and brokerage accounts when it comes to taxes, so that this makes more sense. With retirement accounts, any time money is taken from the account, a taxable event occurs. A taxable event just means that taxes could potentially be owed. Not necessarily that they will be. Taxable events are reported to the IRS. When there are trades within a retirement account, it doesn’t matter. That’s not a taxable event.
The opposite is true for brokerage accounts. When money comes out of the account, it doesn’t matter. That’s not a taxable event. However, when trades occur within a brokerage account, that’s a taxable event. If you sell a position in a brokerage account that has been held for more than a year, that’s when a long-term capital gain rate may apply. If the position has been held for a year or less, that would be a short-term capital gain rate, which is the same as your ordinary income. Long-term capital gain rates are nice because they’re less than your ordinary income. So there’s an opportunity to save taxes.
When we’re planning for distributions in your future and we’re trying to determine which accounts to pull money from, a brokerage account can be a really nice addition because it gives us more options. We can plan around tax brackets and we can look at different strategies like tax gain harvesting if it’s a low income year, or tax loss harvesting if that makes sense in your financial plan. The whole point is to reduce your overall tax burden over your lifetime and a brokerage account may add more possibility for this.
Improve Tax Efficiency With Your Investments
Number four, there may be more asset location opportunities with a brokerage account. I won’t go too much into detail with this but with different investments there’s different tax efficiency. There are some investments that have more tax efficiency than others, and we can place the different investments in different account types in order to improve your tax efficiency. With a brokerage account, we have more opportunity with asset location and with improving your overall tax efficiency. And again, the whole point is just to reduce your overall taxes.
How Not To Use This Account
Now, one quick caveat to this account, or how not to use it. Because trades in this account are taxable events, it doesn’t make sense to use this account for frequent trading. Taxes can add up quickly. This account is best used for long-term planning.
So those are the four reasons why adding a brokerage account to your financial plan may be a good idea. Flexibility is the big one and also there are a lot of tax planning opportunities.
