Skip to main content
Advertiser Disclosure
We do receive compensation from some partners whose offers appear on this page. We have not reviewed all available products or offers. Compensation may impact the order in which offers appear on page, but our editorial opinions and ratings are not influenced by compensation.

The Ascent Logo The Ascent Logo - Blue circle with an A in it and the ascent a motley fool company to the right of that

  • Credit Cards
  • Banking
  • Brokerages
  • Loans
  • Mortgages
  • Knowledge
  • Latest Picks
  • Search Icon Click here to search

Credit Cards

Top Picks
  • Best of January 2021
  • Cash Back
  • Balance Transfer
  • Travel
  • 0% APR
  • Rewards
  • Bad Credit
Knowledge
  • Beginners Guide to Credit Cards
  • How to Rebuild Your Credit
  • Maximize Your Credit Card Rewards
  • Learn More About Credit Cards
Credit Card Tools
  • Compare Cards
Looking for a new credit card?

Explore the best credit cards in every category as of January 2021.

Get started!

Banking

Top Picks
  • Best Savings Accounts
  • Best Bank Accounts
  • Best Money Market Accounts
  • Best CDs
  • Best Checking Account Bonuses
Knowledge
  • Beginners Guide to Banking
  • Everything You Need to Know About Savings
  • Money Market Accounts Made Easy
  • Learn More About Banking
Looking for a place to park your cash?

Check out our top picks of the best online savings accounts for January 2021.

Get Started!

Brokerages

Top Picks
  • Best Brokers of January 2021
  • Best Online Brokers for Beginners
  • Best Options Brokers
  • Best IRA Accounts
  • Best Roth IRA Accounts
  • Best Robo Advisors
Knowledge
  • How to Open a Brokerage Account
  • Beginner's Guide to Brokerages
  • Learn More About Brokerage
Just getting started?

Explore our picks of the best brokerage accounts for beginners for January 2021.

Get Started!

Loans

Top Picks
  • Best Loans of January 2021
  • Best Personal Loans for Bad Credit
  • Best Loans for Debt Consolidation
  • Best Low-Interest Personal Loans
  • Best Personal Loans for Good Credit
  • Best Personal Loans for Fair Credit
Knowledge
  • Personal Loans Made Easy
  • Debt Consolidation Guide
  • How to Pay Off Debt
  • Learn More About Loans
Thinking about taking out a loan?

Before you apply for a personal loan, here's what you need to know.

Get Started!

Mortgages

Top Picks
  • Best Mortgage Lenders of January 2021
  • Best Mortgage Lenders for Poor Credit
  • Best Refinance Lenders
  • Best VA Mortgage Lenders
Knowledge
  • First Time Homebuyers Guide
  • Home Loans Made Easy
  • The Complete Guide to Refinancing
  • How to Get a Mortgage with Bad Credit
  • Learn More About Mortgages
Tools & Calculators
  • Mortgage Calculator
Compare Rates
  • Today's Mortgage Rates
  • Refinance Rates
  • 15-Year Mortgage Rates
  • 20-Year Mortgage Rates
  • 30-Year Mortgage Rates
  • Jumbo Mortgage Rates
  • VA Loan Rates
  • 5/1 ARM Rates
  • 7/1 ARM Rates
  • FHA Mortgage Rates

Knowledge

Knowledge Section
  • All Articles
  • Credit Card Articles
  • Banking Articles
  • Brokerage Articles
  • Personal Loan Articles
  • Mortgage Articles
  • Personal Finance Articles
Recent Articles
  • U.S. Citizens With Undocumented Spouses Can Get Stimulus Checks

    Personal Finance

    U.S. Citizens With Undocumented Spouses Can Get Stimulus Checks
  • Don't Accidentally Throw Away Your Stimulus Check

    Personal Finance

    Don't Accidentally Throw Away Your Stimulus Check
  • Stimulus Check Update: $1,400 Checks Now on the Table

    Personal Finance

    Stimulus Check Update: $1,400 Checks Now on the Table
  • Weekly Mortgage News Roundup for Jan. 15, 2021

    Mortgages

    Weekly Mortgage News Roundup for Jan. 15, 2021
  • The Ascent
  • Best Online Stock Brokers
  • Are Brokerage Accounts Taxable?

Are Brokerage Accounts Taxable?

by: Matt Frankel, CFP  |  Dec. 8, 2020

The Ascent is reader-supported: we may earn a commission from offers on this page. It’s how we make money. But our editorial integrity ensures our experts’ opinions aren’t influenced by compensation.

Picking good investments is only half the battle when investing and growing wealth. The other half is investing in a tax-efficient manner so you keep as much of your gains as possible. Depending on the type of brokerage account, income from capital gains, dividends, and interest may or may not be taxable.

Below, I'll explore the tax issues with investing so you know what to expect when tax time rolls around. I'll also talk about some brokerage accounts that help you avoid taxes on brokerage account investments. 

Tax-advantaged brokerage accounts

Some brokerage accounts, such as specific types of retirement accounts, provide protection against taxation. Many people open individual retirement accounts (IRAs) at brokerage firms in order to avoid taxes on brokerage account investments until withdrawal, or forever.

  • Tax-deferred accounts. A traditional IRA is one of the most common types of tax-deferred brokerage accounts. You contribute pre-tax dollars to a traditional IRA, and then pay ordinary income taxes on the money you withdraw in retirement. You might use tax-deferred accounts to benefit from tax arbitrage. For example, let's say you're currently in the 24% marginal tax bracket, and expect to be in the 12% marginal tax bracket at retirement. It makes sense to use a traditional IRA to avoid paying 24% on your contributions now and pay just 12% on your withdrawals later. (Most 401(k)s, 403(b)s, and other employer-sponsored accounts are also tax-deferred accounts.)
  • Tax-free accounts. A Roth IRA is one of the most common types of tax-free retirement accounts. You contribute post-tax dollars to a Roth IRA, and as a result, any of your withdrawals in retirement are not taxed. Even if you had $5 million of gains in a Roth IRA, you could withdraw them without paying a dime in taxes at retirement. Importantly, you'll need to pay attention to Roth IRA income limits. These may rule out some people from using a Roth IRA to save for retirement.

Regardless of whether you choose Roth or traditional IRAs, investing in a tax advantaged account gives you a huge advantage: You are only taxed on withdrawal (traditional IRAs) or before you make a contribution (Roth IRAs). In contrast, in a taxable brokerage account, you'll owe taxes on brokerage account earnings at every step.

Roth vs. traditional IRA

Deciding between a Roth or traditional IRA can be tricky because you need to predict a number of different variables. To make a perfect decision and avoid taxes on brokerage account earnings, you'd need to know your income, marginal tax bracket, and investment returns, now and into the future. If you're five years away from retirement, you can project these kinds of things with relative precision. If you're 40 years from retirement, it's not so easy.

A common rule of thumb is that Roth IRAs are better suited to younger investors as an investment account for retirement. This is because they're likely to earn more as they age, and could pay higher taxes in retirement than they do in the present. Roth IRAs also have some important advantages, like the ability to withdraw your contributions at any time for any reason without penalty. This is helpful if you need to withdraw money for an emergency, for example.

Soon-to-be retirees are likely in their prime earning years and may be paying higher taxes now than they will in retirement. As such, a traditional IRA might suit them better. Some people divide and conquer, putting part of their savings in a Roth account and another part in a traditional account so as to diversify their tax exposure. There isn't a one-size-fits-all answer for how to approach Roth vs. traditional accounts.

If you're new to investing, the main takeaway is that you're likely you'll come out ahead by deferring or avoiding taxes on brokerage account investments. You can do so with a traditional IRA or a Roth account. Plus, tax-advantaged accounts save you some trouble at tax time compared to a taxable brokerage account.

Taxable brokerage accounts

An ordinary brokerage account that is not a retirement account is a taxable investment account. If you make money because your investments go up in value, or because your investments pay you dividends or interest, this income will be taxed. The taxes on brokerage account income depends on the type and source of the gains or investment income you earn.

Capital Gains

The most basic way to make money investing is the old-fashioned way: by purchasing a stock, fund, or other investment and selling it later for more money. You know the mantra -- “buy low, sell high.”

Money you earn from capital gains is taxed at different rates depending on how long you held the investment. Gains on investments you held for one year or less before selling them are “short-term capital gains.” The taxes on brokerage account short-term gains are taxed as ordinary income.

Holding an asset for more than one year gets you favorable tax treatment on the gains when you sell. For instance, if you buy a stock for $10, hold it for 18 months, and then sell it for $15, you will have $5 of long-term capital gains. Taxes on long-term capital gains can range from 0% to 20% depending on your tax bracket. But they're almost always lower than what you'd pay on short-term capital gains or ordinary taxable income. This is to reward people for investing for the long haul rather than speculating on short-term price movements.

Dividends

Companies often pay out a portion of their earnings in the form of cash dividends to their shareholders to reward them for being part owners of a profitable business. Dividend income from your stock and mutual fund is taxed in two different ways. How dividends are taxed depends on the type of dividend you receive.

  • Qualified dividends. The vast majority of dividends paid by public companies are qualified dividends. This means they qualify to be taxed as a long-term capital gain. There are certain rules about how long you must own a stock to benefit from the lower tax rate on qualified dividends. But the key thing is that qualified dividends are taxed at lower, long-term capital gains tax rates.
  • Unqualified dividends. Some companies do not pay corporate taxes on their profits, and thus the dividends they pay to investors are “unqualified dividends” that are taxed as ordinary income. This generally applies to real estate investment trusts (REITs), master limited partnerships (MLPs), and business development companies (BDCs).

Interest income

You may earn interest on any investment, and you'll generally pay taxes on brokerage account interest income. This could be from a bond, certificate of deposit, or just from holding cash in your brokerage account, the income is generally taxed as ordinary income. There are two common exceptions to this rule, however.

  1. U.S. Treasuries. If you lend money to the U.S. government by purchasing U.S. Treasuries, the income you earn is taxed at the federal level, but it is not subject to state or local income tax.
  2. Municipal bonds. Interest earned from municipal bonds is generally exempt from taxation at the federal level. In many cases, it's also exempt from state and local taxes, resulting in no tax liability for the investor.

When you owe taxes on a taxable brokerage account

Any income you earn in a taxable brokerage account is taxed when the income is realized. If you sell a stock at a gain, that gain is taxable. If you earn interest on your cash balance, that interest income is taxable in the tax year in which it was received. 

Many people falsely believe that any gains or income earned in a taxable brokerage account are not taxable until withdrawn, but that isn't the case. You'll pay taxes on brokerage account income in the tax year you earn it. What matters for taxable brokerage accounts is when the money is earned or gains are realized, not when it is withdrawn and enjoyed.

Most investors use taxable brokerage accounts only if they have already maxed out all of their tax-advantaged investment opportunities. For example, if you are currently maxing out a 401(k) at work, and an IRA you set up yourself, you might then consider opening a taxable brokerage account. This might allow you to save and invest even more money each year. If you're maxing out your 401(k), but haven't yet opened an IRA and want to avoid paying taxes on taxes on brokerage account earnings, an IRA is likely a better bet.

About the Author

Matt Frankel, CFP
Matt Frankel, CFP icon-button-linkedin-2x icon-button-twitter-2x

Matt is a Certified Financial Planner® and investment advisor based in Columbia, South Carolina. He writes personal finance and investment advice for The Ascent and its parent company The Motley Fool, with more than 4,500 published articles and a 2017 SABEW Best in Business award. Matt writes a weekly investment column ("Ask a Fool") that is syndicated in USA Today, and his work has been regularly featured on CNBC, Fox Business, MSN Money, and many other major outlets. He’s a graduate of the University of South Carolina and Nova Southeastern University, and holds a graduate certificate in financial planning from Florida State University.

Like this page? Share it!

Blue Facebook Icon Share this website with Facebook
Blue Twitter Icon Share this website with Twitter
Blue LinkedIn Icon Share this website with LinkedIn
Blue Mail Icon Share this website by email

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.

The Ascent Logo

The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.

btn_facebook-yellow btn_twitter-yellow btn_instagram-yellow

Copyright © 2018 - 2021 The Ascent. All rights reserved.

About The Ascent
About Us Contact Us Newsroom How We Make Money Editorial Integrity Ratings Methodology
Legal
Terms of Use Privacy Policy Accessibility Policy Terms and Conditions Copyright, Trademark and Patent Information
Learn
Credit Cards Banking Brokerage Loans Recent Articles

By submitting your email address, you consent to us sending you money tips along with products and services that we think might interest you. You can unsubscribe at any time. Please read our Privacy Statement and Terms & Conditions.

Back to The Motley Fool