What is a Brokerage Account? Do You Really Need One?

A brokerage account is an investing account that you can open through an online broker and other financial institutions. The account allows you to invest in a range of financial assets including stocks, bonds, and investment funds.

Brokerage accounts work like this. You fill out an online application at an online broker in less than 15 minutes. Once your application is approved, you can transfer money from your bank account to your brokerage account. From there, simply use those funds to buy the investments you want in your account.

Unlike other investing accounts such as IRAs and 401ks that are designed for retirement, or Coverdell ESA or 529 Plans that are designed to save for educational expenses, a brokerage account does not have a "specific" purpose. The purpose of the account is simply to let everyone who wants to invest, invest.

A brokerage account allows you to invest in most common asset classes including stocks, bonds, ETFs, mutual funds, and index funds. Depending on where you hold your brokerage account, you may be able to invest in crypto as well (although this is less common at major brokers).

Some brokerage accounts will also allow you to invest in precious metals such as gold and silver, as well as real estate through a REIT (real estate investment trust). Although you can invest in these assets through a brokerage account, it is much more common for investors to simply hold stocks, bonds and investment funds in their brokerage account.  

The brokerage account is not taxed itself. What is subject to tax are the investments that you hold within your brokerage account. Brokerage accounts are subject to either short or long term capital gains tax. A capital gain is when you sell an asset for a profit.

For example, lets say that you bought a stock for $50 within your brokerage account and then sold it later on for $75. Your profit of $25 would be subject to either a short or long term capital gains tax.  

Additionally, you would not owe any taxes if you sold your investment at a loss. Lets use the same example as before. You bought stock at $50, but sold it for $25. Your loss of $25 is not subject to taxes and is called a capital loss.  

With capital gains explained, you should also understand that you will be taxed at either a short or long term rate. If you held an investment within your brokerage account for less than a year before selling, you would incur a short term capital gains tax.

If you held an investment within your brokerage account for more than a year before selling, you would incur a long term capital gains tax. For short term capital gains tax, you will be taxed at the same rate of your ordinary income from your job.  

For long term capital gains tax, your capital gains will be taxed at 0%, 15%, or 20% depending on your income. For example, if your tax filing status is single and you have an income of $80,000, your long term capital gains tax rate would be 15%. So, if you had a long term capital gain of $10,000, you would owe $1,500 in taxes.

See the chart below for specifics. The numbers below the tax rates are related to your income. If your income is in the range and tax filing status listed, any long term capital gain will be taxed at that rate. (Rates and income ranges are accurate for 2023).

You can contribute as much as you would like to a brokerage account. Since a brokerage account is taxable, the government has no problem if you put lots of money into the account, since they know they will get their piece of it. In contrast, other investing accounts like IRAs and 401ks offer tax free or tax deferred growth.

However, since these accounts offer these tax benefits, the amount you can contribute to them is limited. This can make the brokerage account stand out if you don't qualify or have the option for an IRA or 401k, or have a high income - but we will compare these accounts later on.

You can pull the money out of a brokerage account whenever you would like. Keep in mind that you will either have to pay short or long term capital gains tax when you sell the investments within your brokerage account for a profit.

You can also pull the money out at a capital loss (when you sell your investments for less than you paid for them). Selling at a capital loss can be beneficial at certain times, but that is a topic for another discussion. The bottom line is that you can access the money in a brokerage account whenever you like as long as you are comfortable with the tax implications.

Besides brokerage accounts, IRAs and 401k(k)s are some of the most popular investing accounts for the every day investor. It is important to understand the difference between them. Brokerage accounts differ from IRAs and 401(k)s in two main ways - how the accounts deal with taxes and how flexible the accounts are.

1) How the accounts deal with taxes

As previously noted, brokerage accounts do not provide any tax benefits. Instead, you can sell the investments within your brokerage account at any time, but you can incur either short or long term capital gains tax.

IRAs and 401(k)s differ in this regard as both types of accounts provide a tax benefit. A 401k is an employer sponsored retirement plan. When you contribute to this plan, your employer will take out part of your paycheck each month and contribute it to a pre-selected list of investments offered by your specific plan. (Many employers will also match your contributions up to a set amount).

401(k)s offer either tax deferred or tax free benefits. The tax deferred option is called a Traditional 401k and works like this. Every month your employer will take out a percentage of your paycheck before taxes have been paid on it and put it into your 401k. These contributions reduce your taxable income for the year.

Instead of paying taxes on the dollars today, you are "deferring" the tax bill until you take the money out in retirement. The tax fee option is called a Roth 401k and works in the opposite way of the Traditional 401k. The money that you contribute today is taxed, but when you take the money out in retirement, you owe no taxes.

IRAs, or individual retirement plans, are investing accounts designed to help you save for retirement that are held outside of work. There are a wide variety of IRAs, but the most popular are the Traditional or Roth IRA. Similar to the 401k, these accounts offer tax deferred or tax free growth respectively.

Compare some of the best investing accounts

2) Flexibility of the accounts

Since IRAs and 401(k)s offer tax benefits, the accounts are less flexible than brokerage accounts. First, the amount you can contribute to a brokerage account is unlimited, where as the amount you can contribute to an IRA or 401k is limited (see chart below for details).

Secondly, you can pull the money out of a brokerage account whenever you feel like it as long as you are comfortable with the tax implications. This is not the case for an IRA or 401k, where you must be at least 59 and a half years old before you can withdraw the money.

If you try to take a withdrawal before then, you can incur a 10% penalty and additional income taxes on the amount that you withdrew. Finally, almost anyone can have a brokerage account where as 401(k)s are only available if your employer offers one and there are income limitations to be eligible for a Roth IRA.

The short answer is that it depends. A brokerage account does not provide some of the tax benefits of other accounts, such as IRAs and 401ks, but that does not mean you should ignore the brokerage account as it can have benefits if utilized properly.

Do you value flexibility?

The main advantage that a brokerage account has over other investing accounts is flexibility. A brokerage account gives you flexibility in two ways. 1) The amount you can contribute to the account. 2) The ability to withdraw the money from the account whenever you would like.

Other common investing accounts, such as IRAs and 401ks, limit the amount you can contribute to the account due to the tax benefits. If you want an account in which you can invest as much as you would like, a brokerage account could be the way to go.

Secondly, you can withdraw the money from a brokerage account whenever you would like as long as you understand the capital gains tax implications. Other investing accounts often require you or the account to be a certain age before you can access the money.

Additionally, you can only withdraw money from some investing accounts for a specific purpose. For example, the funds within a College 529 plan can only be used to cover educational expenses. The funds in a brokerage account can be used for whatever you want.

Do you plan to retire early?

For the every day investor, one of the biggest reasons to invest is to save for retirement. With this in mind, many investors use as their main investing accounts to get them to retirement - primarily due to their tax benefits.

However, this can create a bit of a problem if you want to retire early due to the withdrawal rules of these accounts. In general, you can't take money out of an IRA or 401k until you are 59 and a half years old. If you do take money out before then, you can incur a 10% penalty, as well as any applicable income taxes.

If you also save in a brokerage account, you can bridge the gap between your early retirement and the time when you can withdraw from your other accounts. For example, if you plan to retire early at 55, you could withdraw from a brokerage account for 4 and a half years before tapping into your IRA or 401k.

Do you want to retire early?

If you don't currently plan to retire early, but would like to, a brokerage account can help you get there. It could be that you are already saving for your retirement through both an IRA and 401k, but still have money left to invest. It is possible to place these funds in a brokerage account and reach retirement sooner.

Due to the flexibility of the brokerage account, you can use it for whatever purpose you like. You can use it for general investing, retirement saving, saving for a purchase such as a small down payment on a home, saving for a wedding and more. With that being said, the exact way that you should use a brokerage account will depend upon your individual financial circumstances.

You have a couple of options on where to open a brokerage account. If you plan on choosing and managing the investments within your brokerage account, you can open one through an online broker. An online broker will allow you to buy and sell a wide range of investments within your brokerage account.

If you want a more hands off approach, you could open a brokerage account through a robo advisor. A robo advisor is a digital financial advisor that uses algorithms to choose investments that would be best for you based upon answers to a questionaire that you are required to fill out when you first sign to use a robo advisor.

A robo advisor will eliminate the need for you to choose your own investments, but it will also give you less flexibility than holding your brokerage account at an online broker. Regardless of which option you choose, the process to open a brokerage account is the same.

Step 1 - Choose a broker or robo advisor

Your first step to opening a brokerage account is to research a good online broker or robo advisor to hold your account at. Look for companies with strong reputations, low costs, and a range of services. You can check out our picks for some of the top online brokers and robo advisors if you need help finding one.

Step 2 - Fill out an application online

Once you have a broker or robo advisor selected, simply fill out an application online for a brokerage account. The process is simple, but expect to have to provide information such as your address, government ID, social security number, income, and more.  

Step 3 - Fund your account and buy your investments

Once your application is approved, you can transfer money from your bank account to your brokerage account and use those funds to buy your desired investments. If you are using a robo advisor, the funds that you deposit will be automatically invested into the investments the robo advisor selected for you. However, if you are using an online broker, you will need to manually choose and buy your investments.

Don't miss this step. Many new investors make the mistake of believing they have made an investment once they transfer money from their bank account to their brokerage account. However, you need to take the funds within your brokerage account and then buy investments through your broker.

The bottom line is that a brokerage account is an investing account that you can open online through an online broker or robo advisor in order to buy a range of investments including stocks, bonds, mutual funds, index funds, and ETFs.

A brokerage account provides more flexibility than other investing accounts. You can contribute as much as you would like, have access to a wide range of investments, and withdraw the money when needed as long as you understand the capital gains tax implications.

Brokerage accounts do provide some benefits that other investing accounts do not, but you should understand how and why you are going to use a brokerage account before opening one. We recommend speaking to a licensed financial advisor if you need help figuring this out.

Check out our beginners guide to investing for a practical guide on how to get started.