Investing is a top priority for most Americans (80%) this year, and the taxable brokerage account is a common part of a diversified investment portfolio.

What is a brokerage account?

A brokerage account is an investment account for buying and selling securities through a financial institution. 

There are many different platforms that enable opening a brokerage account, and the investments you’ll have access to depend on the platform you choose. Many brokerage accounts allow you to trade individual stocks and bonds, as well as pooled assets like mutual funds and exchange-traded funds (ETFs). 

How do brokerage accounts work? 

Instead of just holding money, a brokerage account can hold securities as well. When you sign up for the account, you can connect it to your bank account and transfer funds into it. With the money in your brokerage account, you can then purchase stocks, bonds, mutual funds, and other investments. 

When you place buy-and-sell orders within your brokerage account, the brokerage firm executes them on your behalf. In exchange for this service, the firm may charge a fee, either as a percentage of your assets or as a flat fee for each trade. 

Unlike other types of investment accounts, taxable brokerage accounts have no limit on the amount you can invest per year. 

Investing involves risk, and there’s no guarantee you’ll earn money. However, stock market returns have averaged about 10% annually for nearly the last century, as measured by the S&P 500® index.¹ Ideally, you could watch the assets in your brokerage account grow over time. However, past performance is not a guarantee of future results. 

Depending on how you’re earning money, you may be subject to certain taxes. For example, in a taxable account you’ll pay taxes if you earn interest or dividends from the investments you currently hold. You may also be on the hook for capital gains taxes when you sell your investments. 

3 types of brokerage account arrangements 

When you decide to sign up for a brokerage account, you’ll have several types to choose from. Each type of brokerage account arrangement has its own unique characteristics and benefits. 

Self-directed online brokerage account 

You can open a self-directed online brokerage account with most major brokerage firms.  

Once your account is open, you manage your own investments. You can place buy-and-sell orders at any time, building your portfolio with individual stocks, bonds, or diversified investments like mutual funds and ETFs. 

These brokerage accounts are the most hands-on since you’re responsible for choosing your own investments. The self-directed brokerage account is intended for knowledgeable investors who understand the risks associated with the account. This option may not be suitable for those who don’t feel comfortable selecting their own asset allocation. 

Managed brokerage account 

A managed brokerage is one that’s overseen by an advisor or advisory firm. Rather than having to choose your own investments, your investment manager or financial advisor chooses them on your behalf. Before building your portfolio, your investment manager will get to know more about your financial goals, risk tolerance, and time horizon and will choose an asset allocation that’s appropriate for you. 

In exchange for them managing your portfolio, investment managers generally charge a fee for their services. In some cases, advisors may earn a commission from the products they recommend to you. In other cases, they charge a flat fee or one that’s based on a percentage of your assets under management.  

This type of brokerage account arrangement is most suitable for investors who prefer personalized, professional management and advice.

Robo-advisor brokerage account 

A ”robo-advisor” account is another type of managed brokerage account, but rather than being managed by an individual advisor, it’s managed by a computer algorithm. When you sign up for a robo-advisor, you’ll answer questions about your financial goals and situation. From there, the advisory firm’s algorithm will select investments. 

With a robo-advisor option, you often pay less money but miss out on the benefit of having a financial professional you can talk with about life’s big money moves. It may be a good option for investors who are cost-conscious. 

Read more: In financial planning, AI has entered the room. Where does it fit in? 

Individual brokerage account vs. other account types 

When you open a brokerage account, you can choose between either an individual or a joint account. An individual account has just one owner. A joint account, on the other hand, is co-owned by two more individuals, typically spouses. 

Joint brokerage accounts can take a few different forms, including Joint Tenants with Rights for Survivorship and Tenants in Common. The key difference between these accounts is what happens if one owner dies.  

In the case of Joint Tenants with Rights of Survivorship, both owners have equal ownership of the account. If one account-holder dies, the other solely owns the account. In the case of Tenants in Common, each owner owns half of the account, and if one owner dies, their share goes to the person designated in their estate plan. 

It’s important to note that while taxable brokerage accounts can be jointly owned, retirement accounts can’t. All retirement accounts are individual accounts. 

How to open a brokerage account 

Opening a brokerage account is a simple process that can often be done in just a few minutes. After researching the types of brokerage accounts and completing your application process, you follow a couple steps.

Fund the account 

In order to invest in your brokerage account, you have to provide a way to fund it. For taxable brokerage accounts, often the simplest way is to connect your bank account to your brokerage account and transfer funds in. You may also be able to fund your account with a debit card.  

Keep in mind that some brokerage accounts and/or investments have minimum investment requirements. Determine if those apply so you can fund your account with enough money. 

Start trading 

Once your account is open, you can start investing. Before you do, consider spending some time exploring your new account to make sure you know where everything is and how it works. The brokerage firm should have a customer service contact if you run into questions along the way. Finally, once you’re ready, you can begin placing buy and sell orders to start investing in your account. 

Can I open a brokerage account for my kids? 

Although you must generally be at least 18 years old to open a brokerage account, parents and other adults can open brokerage accounts—known as custodial accounts—on behalf of minors.  

Overview of custodial accounts 

A custodial account is a brokerage account that an adult (usually a parent or another family member) can open on behalf of a child. The custodian is responsible for managing the investments until the child reaches adulthood. 

Ownership of funds in custodial accounts 

While a custodian manages the account, anything transferred into it is the legal property of the minor. So, if you contribute money to your child’s custodial account, you can’t take it back. Once the child reaches the age of majority, which is 18 in most states, they’ll get full control of the custodial account and can use the money for anything they want. 

Alternatives to direct custodial accounts 

Though custodial accounts have some key benefits, there are some downsides. First, you may not be comfortable with your child gaining access to a large sum of money when they turn 18. To get around this, you could open a brokerage account in your own name with the funds inside it earmarked for your child’s future. Ultimately, you own the money in the account and have the say over how it’s used. 

Another option is to open a tax-advantaged account for your child, such as a 529 plan or a Roth IRA. A 529 plan is a tax-advantaged account designed to help you save for your child’s college education. Though the money can only be used for qualified education expenses, investment gains and withdrawals are tax-free. In the case of a custodial Roth IRA, your child must have their own earned income, but if they do, they can enjoy all of the benefits a Roth IRA has to offer. 

Read more: How we save and invest for our kids’ future 

Benefits of opening a brokerage account 

A brokerage account can be a powerful tool to help you grow wealth and save for large financial goals. There are several key benefits to opening a brokerage account. 

Potential for higher returns 

The most important benefit of a brokerage account is the potential return. Many people save for their goals in a savings account, but a standard savings account may not offer the return you want. Even a high-yield savings account offers a return that’s often considerably lower than the average stock market return in the long run. Your money has the potential to grow more for retirement and other big goals if you invest in a brokerage account versus a typical savings account.  

There is no guarantee, though, that investments in a brokerage account will provide a higher return than other savings options. It is possible to lose money investing in securities. On the other hand, depositing your savings at an FDIC-insured bank ensures that your money is protected in the event of bank failure. Your deposits are automatically insured to at least $250,000 at each FDIC-insured bank.² There are no such protections with a brokerage account. 

Diversified investment options 

When you invest in a brokerage account, you’ll have a wide range of investment opportunities to choose from. Though your options vary slightly depending on your provider, you can generally invest in stocks, bonds, mutual funds, ETFs, and even more speculative investments like options. The variety of options available makes it easy to build a diversified portfolio. 

Flexibility in trading 

The assets in your brokerage account are yours to do what you want. Depending on your risk tolerance and goals, you can buy securities to hold for many years, actively trade stocks day to day, or something in between. Each person can make their own investment decisions based on market conditions and their personal strategies. 

Taxable brokerage accounts vs. retirement accounts 

One of the most common questions people have about taxable brokerage accounts is how they differ from retirement accounts. And while the two have some important similarities, they also have several key differences. 

Both brokerage accounts and retirement accounts are investment accounts where you can buy and sell securities. However, the two accounts differ when it comes to their tax implications, contribution and withdrawal rules, and primary uses.  

Let’s talk about some of the other key differences between taxable brokerage accounts and retirement accounts: 

Taxes 

Taxable brokerage and retirement accounts differ in terms of their tax treatment. Taxable brokerage accounts offer no tax benefits. You’ll deposit money after-tax into the account. Additionally, any investment returns will be subject to either capital gains taxes or ordinary income taxes, depending on the type of income generated. 

On the other hand, your retirement account has some key tax advantages. For a traditional IRA, you can contribute with pre-tax dollars, meaning you don’t pay income taxes on that portion of your income. Any growth is tax deferred until you take a distribution. For a Roth IRA, your contributions aren’t tax-free, but your withdrawals are. 

Read more: What are Roth IRA taxes & how do they work? 

Contributions  

Taxable brokerage accounts have no contribution limits, meaning you can invest as much as you want throughout the year. However, tax-advantaged retirement accounts have caps on annual contributions. The most common types of accounts, 401(k)s and IRAs, have contribution limits of $23,000 and $7,000, respectively.³ 

Withdrawals 

Retirement accounts have penalties for withdrawing money before age 59 ½ if you don’t meet certain other exceptions. 

Primary use 

The money in your brokerage account can be used for any purpose. You can use your account for day trading or to save for long-term goals. Meanwhile, the funds in your retirement account are meant to be saved for retirement. 

Tax treatment of brokerage accounts vs. retirement accounts 

There are no real tax benefits to investing in a taxable brokerage account. You fund your account with after-tax money, pay taxes on any interest and dividends you earn on your current holdings, and pay capital gains taxes if you sell an investment for more than you bought it. 

In the case of a retirement account, your contributions are traditionally tax-deferred. Either they come out of your paycheck before taxes, or you can deduct them on your income tax return. Once the funds are in your account, any earnings are tax-free until you withdraw them. 

You can buy and sell securities without incurring taxes. Then, you’ll pay income taxes on the money when you withdraw it from your retirement account. 

There are certain types of retirement accounts that use Roth contributions. In this case, you contribute with after-tax dollars, just as you would a brokerage account. The difference is the money in your Roth retirement account can be taken tax free with a qualified distribution. 

Understanding contribution limits in brokerage accounts 

There are no contribution limits on taxable brokerage accounts. You can invest as much as you want in any year. But for retirement accounts, there are some limits. 

The amount you can contribute to your retirement account depends on the type of account and your age. For a 401(k) plan in 2024, you can contribute up to $23,000 per year, with an additional $7,500 catch-up contribution allowed if you’re 50 or older. For individual retirement accounts (IRAs) in 2024, the contribution limit is $7,000 per year with an additional $1,000 catch-up contribution. 

There are some other limitations on who can contribute to retirement accounts and how much. You can only contribute to a 401(k) if your employer offers one. For IRAs, you may be limited as to whether you can contribute, how much you can contribute, and whether you can deduct your contributions based on your household income. 

Read more: How to open an IRA 

Withdrawal rules in a brokerage account 

Each of the different types of brokerage accounts has its own withdrawal rules. Typically, taxable accounts have more flexible withdrawals, while retirement accounts have stricter withdrawal rules. 

Flexibility of taxable brokerage accounts 

Taxable brokerage accounts allow for flexible withdrawals. Generally, you can take money from your account at any time and for any reason. For this reason, taxable accounts can be ideal for saving for shorter-term goals. 

Restrictions in retirement accounts 

Retirement accounts have stricter withdrawal rules than taxable brokerage accounts. The IRS generally requires you to leave the money in your retirement account until age 59 ½. If you take the money out early and don’t meet certain exceptions, you could be on the hook for a 10% penalty on top of any income taxes you owe. 

Exceptions to retirement withdrawal rules 

There are several situations where the IRS allows you to withdraw money from your retirement accounts before age 59 ½ without being subject to the standard 10% early withdrawal tax.⁴ The exceptions vary slightly depending on whether you have a 401(k) or an IRA, but some common exceptions include paying for a birth or adoption, becoming permanently and totally disabled, dealing with a family emergency, paying for medical expenses, and more. 

Margin account vs. cash account 

When you open a taxable brokerage account, you can choose between a cash account and a margin account. We’ll discuss each type of account further below. 

What is a brokerage cash account? 

A cash account is the most common type. It allows you to buy securities with money you transfer into your account. If you have $1,000 of cash in your brokerage account, you can buy up to $1,000 of securities.  

What is a brokerage margin account? 

A margin account allows you to buy securities worth more than the money you have in the account. Rather than having to pay for your investments with your account balance, you borrow money from the brokerage firm to buy them. You’re responsible for providing a percentage of the funds, and the securities themselves serve as the collateral for the loan. You’ll then have to repay the loan, regardless of how the investment performs. 

Are brokerage accounts right for you? 

While investing involves risks, you are protected against certain types of losses. 

The Securities Investor Protection Corporation (SIPC) is a non-profit corporation that was created under the Securities Investor Protection Act. SIPC insures the cash and securities in your investment account to ensure that, if the brokerage firm goes bankrupt, you’ll be protected. The SIPC protects $500,000 per customer per brokerage firm, with a limit of $250,000 in cash. 

SIPC insurance won’t protect investors from market downturns — those can still cause your portfolio to lose value.  

Tax implications of a taxable brokerage account 

A taxable brokerage account could result in several different types of taxes. Let’s talk a bit more about those in the sections below. 

Capital gains taxes 

Capital gains taxes apply to the profit you make from selling an asset at a higher price than you purchased it for. For example, if you buy a stock for $200 and sell it for $250, you’ll pay capital gains taxes on the $50 profit. 

Your tax rate depends on whether your gain is long-term or short-term. A long-term capital gain is when you’ve held the asset for more than one year. Long-term capital gains are taxed at rates of either 0%, 15%, or 20%. A short-term capital gain is when you’ve held the asset for one year or less. Short-term capital gains are taxed at income tax rates. 

Read more: How to avoid capital gains tax 

Dividend taxes 

Dividends are payments made from companies to their shareholders as a way of sharing their profits. Dividends are always subject to taxes, but the way they’re taxed can vary. Dividends can be either ordinary or qualified. Ordinary dividends are taxed at income tax rates, while qualified dividends are taxed as long-term capital gains. 

Interest taxes 

If you invest in bonds and other interest-bearing investments, then you’ll have to pay taxes on that interest income. Interest is taxed like ordinary income, meaning at your income tax rates. 

Tax reporting requirements 

If you earn capital gains, dividends, or interest on your investments, it's your responsibility to report that income to the IRS and pay taxes on it. There are different forms you’ll have to file with your income tax return depending on the type of investment income you have. 

Keep in mind that just because you don’t report investment income to the IRS doesn’t mean the IRS doesn’t know about it or that you won’t have to pay taxes on it. Your brokerage firm will report your investment earnings to the IRS, too, and failing to report and pay taxes on that income will result in further penalties on top of the taxes you’ll owe. 

Is a brokerage account right for me? 

Whether a brokerage account is right for you depends on several factors, including your other investment accounts and your financial goals. 

In general, financial professionals recommend prioritizing your retirement savings over other investments. First, these investments are tax-advantaged, while those in your taxable brokerage account aren’t. Additionally, many employers offer matching contributions in their 401(k) plans. If you’re eligible for an employer match, make sure to prioritize that. 

Once you’re contributing enough to your various retirement accounts to meet your long-term goals, you may want to consider opening a taxable brokerage account, too. These accounts come with more flexibility, meaning you can use the funds for mid-term goals that you wouldn’t be able to fund with a retirement account. Examples could include buying a home or sending your child to college. Of course, this flexibility also comes at a cost since you’ll face a higher tax burden on investments in a taxable brokerage account than in a retirement account. 

Financial professionals don’t recommend investing any money you plan to need within the next few years. If you’re saving for a house you plan to buy in three years, for example, you may not want to save in an investment account. A high-yield savings account is likely a better fit. However, if you’re buying a house in more than five years, a brokerage account may be a good option.