Brokerage account, also known as your taxable account.
If you have a Wells Fargo, a Betterment, or a Robinhood account, these are all brokerage accounts. They allow you to invest after-tax dollars into thousands of individual stocks, mutual funds, or index funds, trade an unlimited amount, and access your money whenever you want.
For these benefits however, there’s one big downside; taxes.
Your gains are taxed every year in a brokerage account
When you have a brokerage account, not only do you have to pay capital gains tax when you sell the stock, which in the best case is 10% of your gain, you also owe taxes every year. Even if you aren’t trading or selling your investments.
That’s right, you owe taxes on your brokerage account ever year, even if you aren’t trading or selling.
Your dividends will be taxed annually whether you reinvest them or not, because they’re considered income. There’s two types of dividends:
- Ordinary dividends – taxed like ordinary income at your marginal rate.
- Qualified dividends – taxed similarly to capital gains.
Want to see it in action? Open your 1099-DIV that you receive from your brokerage to see your qualified and ordinary dividends amounts. If you use TurboTax to file taxes, you might not have realized that you’ve been paying taxes for this income, but you do indeed owe taxes.
This is why we try to stay away from brokerage accounts. These taxes add up (link to compounding fees article), and we need to stay away from them.