401Ks And IRAs Reign Supreme, But Here’s Why You Shouldn’t Overlook Taxable Brokerage Accounts

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Yes, 401(k)s are awesome. Roth IRAs are amazing. But what about the personal taxable brokerage account?

Is there a place for a regular, boring personal brokerage account in today’s investing world?

In my opinion, yes. No doubt.

For a large number of people, using a personal brokerage account is a necessity if you want to reach your investing goals. There are simply too many restrictions around tax-advantaged accounts (like 401(k)s and Individual Retirement Accounts) for you to use them for all of your investing needs.

Don’t get me wrong, tax-advantaged accounts are better than personal brokerage accounts nine times out of ten. But what about that one time? When should you be considering a brokerage account?

We’ll walk through all of that and more, but first, what even is a personal brokerage account?

What Is A Personal Brokerage Account

In layman’s terms, a personal brokerage account is a taxable investing account where you can buy various investment vehicles, including stocks, bonds, index funds, and more.

These days, most brokerage accounts can be opened online. Though, if you want the full-service feel, you can still open brokerage accounts in person too.

In either situation, they are opened through a firm or company through which you can buy the investment vehicles. You’re not buying them yourself. And for that reason, they typically charge you a small fee per transaction. It’s also generally a bad idea to try to time the market or buy individual stocks anyway.

Funding a brokerage account is actually very similar to opening an IRA, and you usually have a few options, including:

  • Connecting your bank account and making an online transfer
  • Mailing a check
  • Visiting in person and depositing a check or cash
  • Wire transfer

Once funded, you’re off to the races and can start buying and selling investments as you please (although, frequent trading is not recommended!).

There are many pros and cons to using a personal brokerage account compared to other tax-advantaged accounts. Below, we’ll first walk through some of the great reasons you’d want to consider a personal brokerage account.

The Benefits of a Personal Brokerage Account

Flexibility

The first and arguably biggest benefit of personal brokerage accounts is that there are virtually no restrictions on them.

With Roth IRAs, you have to monitor your contributions and start withdrawing money at a certain age. With 401(k)s it’s largely the same story. There are rules to be aware of, and frankly, no one likes that many rules.

In a personal brokerage account, there is no need to worry about things like:

  • Annual contribution limits
  • Early withdrawal penalties
  • Mandatory withdrawal dates

Like a kid who just got their license at 16, you’re finally free!

A lot of Investing Options

Another big perk of personal brokerage accounts is the wide variety of investment options they provide, assuming you choose your online broker wisely, of course.

I’ll make that part easy – online brokers like Charles Schwab and Vanguard are great choices. They both offer a wide range of low-cost index funds and ETFs that are perfect for new and seasoned investors alike. Having a personal brokerage account with either of these online brokers is essentially like standing in front of an all you can eat buffet – where to start!?

This, of course, is compared against a 401(k) where you don’t always get the same variety of options. If you’re super unlucky, you’ll be stuck choosing between high-cost mutual funds and high-cost target-date funds. If you’re more fortunate, you’ll have a few low-cost index funds to choose from. Either way, not as good as the personal brokerage account (or Roth IRA in this situation) where your options can appear to be limitless.

Of course, at the end of the day, the smartest thing to do might be to simply create a 3 fund portfolio. In a personal brokerage account, you’ll have no shortage of great options to create a good one. And hey, 3 fund portfolios are called lazy portfolios for a reason – they are super easy to set up and maintain!

If you are still unsure of what to do, just read this guide on how to start investing and you’ll feel super confident as you get started.

Ease of Use

Personal brokerage accounts also offer the best online platforms. They’re easy to use, which is important when it comes to investing. There is no need to make investing any more complicated than it already is.

As mentioned above, Charles Schwab and Vanguard both have easy to navigate platforms. There are also a load of new brokers with even better interfaces, like Robinhood. I’m not saying you should choose a broker based solely on their ease of use or iPhone app, but it sure is a nice benefit.

Plus, as it relates to “flexibility” (mentioned above), not having to worry about rules and restrictions just makes things even easier than they already were. The lack of rules is why a personal brokerage might be the best place to start investing if you are a newcomer. Then, once you have your feet wet, you can take the small next step into tax-advantaged accounts. Like IRAs.

You can also open a regular brokerage account with Robo-advisors like Wealthfront and Betterment. If anything is clear, it’s that you have a ton of options.

When to Use a Personal Brokerage Account

So personal brokerage accounts have some perks – good to know. But when is the right time to use them? Are they right for everyone?

In my experience, there are two scenarios that come up that are prime opportunities to use a personal brokerage account.

Brokerage Accounts Are Great If You’re New to Investing

As I mentioned, a personal brokerage account is a great “intro” account for new investors. It’s easy to set up, easy to manage, and there aren’t any complicated rules you need to remember.

While it certainly isn’t the best account you can open at first, it is the easiest.

And if you’re currently not investing because “it’s too complicated” (aka, “not easy”), then opening a personal brokerage account is a great first step to get in the game. Once you’re in and comfortable, you can then make refinements from there. Just remember that the best investments are the most simple.

It’s kind of like how basketball players can’t go straight from high school to the NBA anymore. Is it good for their wallet? Not necessarily. But does it give them great experience to help prepare them for the next level? No doubt!

A personal brokerage account can be your college basketball career…

Brokerage Accounts Are Amazing If You Have Maxed Out Your Tax-Advantaged Accounts

A second opportunity I see for using a personal brokerage account is an obvious one – you have maxed out your tax-advantaged option.

In 2019, a 401(k) has a $19,000 annual contribution limit. An IRA has a $6,000 limit. If you are fortunate enough to be maxing both of these accounts out and looking to invest more, then a personal brokerage account might be your only option. Don’t forget to take advantage of your HSA if you have one of them too!

Luckily, it’s not a bad option. It gives you a way to continue to build your wealth in the stock market beyond what the government incentivized accounts can do for you. I mean, Bezos certainly doesn’t have all that Amazon stock sitting in a 401(k), right?

Why You Should Still Use Tax-Advantaged Accounts

To finish this personal brokerage account 101 lesson, I want to make sure you don’t have the wrong impression: tax-advantaged accounts are better than personal brokerage accounts. Most of the time.

In the simplest way I know how to show it, here’s why.

With tax-advantaged accounts, you pay fewer taxes (sometimes no taxes!). What the?!

Essentially, while your 401K or IRA are still taxed as income, they are not subject to capital gains taxes. On the other hand, investments you make outside of those accounts are subject to capital gains taxes. And the cash you use to invest was already taxed as income (that’s how you got it in your bank account!).

Here’s an example of what happens to your money in a 401(k) account vs a personal brokerage account. 

Assumptions In The Example Below:

  • Your Annual Income: $50,000
  • Annual Living Expenses: $33,750
  • Income Tax Rate: 25%
  • Capital Gains Tax Rate: 20%
  • Amount Available to Invest: $5,000 (pre-tax)
  • Market Growth 7%

I understand that some of these assumptions are simple, but I just want to use it to highlight the difference between taxable brokerage accounts and tax-advantaged accounts.

Let’s assume you earn $50,000 annually and can afford to invest $5,000 PRE-TAX dollars annually since your annual living expenses are $33,750.

Since the 401(k) contributions are made pre-tax, you can invest the full $5,000. However, the contributions in your brokerage account are made in after-tax dollars, which means you can only contribute $3,750 annually.

You might be thinking, “why can’t I just put the full $5,000 in the brokerage account?”

The reason is that you need that money to pay bills (rent, groceries, utilities, family outings, vacation, etc.).

If you use your 401(k) to invest it will look like this:

$50K salary — $5,000 pre-tax 401(k) contribution = $45,000 of taxable income.

$45,000 taxable income — 25% income tax rate = $33,750.

If you use a taxable brokerage account to invest it will look like this:

$50K salary — 25% income tax rate = $37,500.

$37,500 after-tax salary — $3,750 brokerage investment = $33,750.

So in both scenarios, you end up with the perfect amount leftover for your living expenses ($33,750), except due to the higher taxes you can’t invest as much money in the brokerage account.

Brokerage Account vs 401k Account

When you invest 10% of your income pre-tax (a full $5,000), like in a 401(k), your portfolio grows to nearly $1 million in 40 years before taxes! After the 401(k) gets taxed at withdrawal it drops to $748,632.

When you invest 10% of your income post-tax (only $3,750), like in a personal brokerage account, your portfolio grows to only $628,905 after capital gains taxes. At an annual contribution of $3,750, you’ve made $150,000 in total contributions. That means you’ve made $598,632 in capital gains which are taxed 20% using our assumptions above. After deducting capital gains, we get to our final total of $628,905.

That’s about $120,000 less than the 401(k) when it’s all said and done!

Not paying capital gains taxes adds up over time. And that is why tax-advantaged accounts can be superior!

One important aspect that we excluded to simplify the example is fees. The fees you pay on your brokerage account or 401K can greatly influence your total returns. Some 401Ks charge unreasonably high account and maintenance fees. The same applies to the specific investments that you make. That’s why so many investors love low-cost index funds in their portfolios.

Get Started Today

The most important thing you can do is get started today! Every day you wait to invest means less money in your future pocket. So whether it’s a 401(k), IRA, or plain-old brokerage account, just get started!

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9 thoughts on “401Ks And IRAs Reign Supreme, But Here’s Why You Shouldn’t Overlook Taxable Brokerage Accounts”

  1. thanks for article but isn’t the taxes on the brokerage account just on the capital gains only after the 40 years and not on the already taxed income also

    Reply
    • Hi Shane, yes, that’s correct. I updated the article to make it more clear and accurate. Thanks for the feedback!

      Reply
  2. Thanks, this was easy to understand. I never really understood why tax implications from a 401K allowed me to invest more money than a taxable brokerage account.

    Reply
  3. You state: “Not paying capital gains taxes adds up over time. And that is why tax-advantaged accounts are always superior!”

    But you neglect to consider the management and record keeping fees of a 401k. For example, total fees for my 401k are about 1.5% annually.

    Taking a 1.5% annual management fee into account brings the 401k after tax total down to $499,135. Completely flipping things around in favor of taxable brokerage accounts.

    Reply
    • Hi Eric, thanks for pointing that out. We ignored fees since investmen-level or account-level fees vary so widely. But you’re right, using the phrasing “always superior” is too definitive. I went ahead and changed that. I will also add a note with fees since they can influence the results widely. Thanks for reading and for leaving the thoughtful feedback.

      Reply
      • I find fees to be the most important part in taking this decision so this article is incomplete and actually misleading. It needs 5 more paragraphs on fees, the average fund fees and the calculation how that affects the total.

        Reply

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