How Choosing the Wrong Brokerage Account Could Cost You

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  • There are different kinds of brokerage accounts you could open.
  • Some accounts provide tax benefits.
  • Missing out on tax breaks by choosing the wrong brokerage account could be an expensive mistake.

Don't cost yourself thousands of dollars by making the wrong choice.

If you want to invest, you'll need a brokerage account. But there are many different kinds of brokerage accounts you could open, and choosing the right one is crucial. If you make the wrong choice, you could actually end up costing yourself hundreds or even thousands of dollars over the course of your investing life.

Here's why.

Picking the wrong account could be an expensive mistake

Picking the wrong brokerage account could end up costing you money because some accounts provide tax advantages but others do not.

If you are investing for retirement, for example, you'll likely want to put your money into one of the tax-advantaged accounts rather than a taxable brokerage account. By doing so, you could either receive a deduction for money you contribute or be able to withdraw money from your account tax free as a retiree. Your money can also grow over time without you having to pay capital gains on the investments each time you sell one for a profit.

The tax savings available from these retirement accounts can be considerable. Say, for example, you opt for a traditional IRA which allows you to make deductible contributions. In 2021, you can deduct up to $6,000 in contributions you make, or $7,000 if you are eligible for catch-up contributions if you are over the age of 50. Since you can deduct this amount from your taxable income, provided you meet the income qualifications, you will not owe the IRS a cut of it.

If you're in the 22% tax bracket and avoid owing taxes on $6,000, you would reduce your tax bill by up to $1,320. If you didn't invest in an IRA, though, and you instead put money earmarked for retirement in a taxable brokerage account, you could end up missing out on this deduction. The $1,320 in savings means your retirement account contribution actually only ends up costing you $4,680 because of the government subsidizing the investment.

It's much easier to invest when you get this tax savings and there's no reason to miss out on it if you know you're going to be using the money you're saving for your later years. But, if you pick the wrong type of brokerage account, that's exactly what could happen.

On the other hand, if you will need the money that you're investing for purposes other than retirement, you wouldn't want to choose a tax-advantaged account like an IRA that has limits on your withdrawals because you'd likely be hit with a 10% penalty if you took the money out before retirement age. In this case, a taxable brokerage account would be a better bet.

You'll also need to choose between traditional accounts that offer the upfront tax break and Roth accounts that don't provide tax-deductible contributions but allow you to withdraw money tax free as a retiree. If you expect your tax bracket to be lower as a senior, choosing a traditional IRA could provide considerable tax savings, although the specific amount will depend on the difference in your tax rates.

Research each different kind of account carefully, learn the rules for investing, taxes, and withdrawals, and make certain you're choosing the account that makes sense for your needs. That's the best way to ensure the brokerage account you've chosen is the right one for you.

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