Is a brokerage the “most underrated” account in personal finance?

Hi everyone,

I had a story published on Yahoo last week, all about DINKs (dual income, no kids) and their budgets. Be warned: You may be as jealous as I am of some of these salaries. Yahoo published this fun Instagram carousel tied to the story, too!

In today’s issue:
1. The “most underrated” account in personal finance
2. On my radar

My favorite series over on The Purse is 30-something, where I basically write about figuring out money stuff in my 30s. Today’s 30-something is about leveling up your finances once you have the basics down, meaning no debt (aside from a mortgage or car loan and arguably student loans), your budget mostly works, and you’re already saving/investing for retirement.

In it, I talk about brokerage accounts, and I wanted to get into them a little more here—I’ve noticed more interest in them lately, and seven different certified financial planners recommended them for that article, with one calling it the “most underrated account in personal finance.” While I’ve had one for years I never paid it much attention (or, frankly, much money) before. (One reason: I wasn’t allowed to invest in anything outside of index funds at the financial publications I worked for because ethics, so it wasn’t a priority!)

Before we begin: If you haven’t started investing for retirement yet, you don’t really need a brokerage. Do that first—preferably via a Roth—and then you can come back to this newsletter.

A taxable brokerage account is an investment account that is not specifically tied to retirement. That makes it different from a 401(k) or IRA, which everyone here is probably familiar with.

The biggest difference between all of these investment accounts is taxes: The government wants to incentivize you to save for retirement, so contributions to 401(k)s and traditional IRAs generally lower your taxable income when you make them, and grow tax-deferred (there’s some technical stuff here we don’t really need to get into, but just know that these accounts are tax efficient/advantaged). When you withdraw money in retirement, you pay income taxes then at your ordinary rate. Roth-style accounts, on the other hand, grow tax-free because you contribute money you’ve already paid taxes on.

Brokerages don’t have those tax benefits. You make contributions with money you’ve already paid taxes on, and you pay taxes on any gains when you make a withdrawal. That said, you don’t pay income taxes—you pay capital gains taxes. And those rates are much lower than income tax rates.

Currently, a capital gains rate of 0% (yes, nada) applies to taxable income less than or equal to:

• $48,350 for single filers and married filing separately

• $96,700 for married filing jointly and qualifying surviving spouse

• $64,750 for head of household

And a capital gains rate of 15% applies to taxable income that is:

• $48,351 to $533,400 for single filers

• $48,350 to $300,000 for married filing separately

• $96,701 to $600,050 for married filing jointly and qualifying surviving spouse

• $64,751 to $566,700 for head of household

A tax rate of 20% applies to any income over those higher thresholds. So if you are single and somehow pull out over $533,400 in investment gains in one year, you pay 20% on the portion of it over $533,400. That’s still lower than the federal income tax rate for someone earning $48,476 in wages.1 Pretty crazy!

(This is one of the reasons why rich people get paid in stock rather than wages.) (You have to hold the investments for at least one year to get that long-term capital gains rate, otherwise you pay your ordinary income tax rate.) (You’ll also pay taxes on dividends but that’s not super relevant here.)

Another difference between brokerages and retirement-specific accounts: There are no contribution limits and, because the money is yours and has already been taxed, you can make withdrawals at any time for any reason with no penalty.

So you can see how this can be beneficial once you’ve got your financial foundation in place. You can (hopefully) grow your contributions, and take distributions whenever needed at the much lower capital gains tax rate. Of course, growth isn’t guaranteed with investments, which is why financial experts say not to contribute any funds you will need in the next three to five years.

While you can use the funds for whatever you want—as a backup emergency fund, to save for a house, for early retirement, just for fun—financial planners advise using the accounts as another retirement income stream. This gives you flexibility with what account you are taking disbursements from and when.

Ideally, you’ll be able to pull income from: Pre-tax retirement accounts, post-tax retirement accounts, taxable accounts, Social Security, and cash.23 One financial planner put it like this: Having all of these different income sources allows you to effectively choose your tax rate in retirement.

For example, let’s say you stop working at 64 but want to hold off claiming Social Security for a few more years so that the payments are a little bit bigger. Withdrawing funds from a brokerage in this year can make more sense than from a retirement account, because you’ll pay very little in taxes while allowing your tax efficient retirement accounts to keep on compounding longer.

This is admittedly a lot to consider, especially if you already have one or two other accounts for retirement and you are still decades away from accessing them.

The hard thing about personal finance is that it’s personal. I have 0 insight into your finances or goals, so there’s no real advice I can give on if you should contribute to a brokerage or not (also I’m not a certified financial professional so you shouldn’t take advice from me anyway). Many of you are likely already doing it.

But here’s how I’m looking at it:

• I don’t have any debt, and while I could be investing more for retirement, throwing a little bit of money into a brokerage each month isn’t likely to break my bank account.

• I have a pool of pre-tax money (my rollover IRA) and post-tax money (my Roth), so adding a chunk of taxable money makes sense.

• Contributing to a brokerage isn’t my top priority right now, but it’s a nice-to-have.

• I’ve never regretted setting a little bit extra money aside.

Plenty of people invest via a brokerage without checking off all of these other boxes—ultimately it comes down to personal preference. That said, if you aren’t contributing in any significant way to a retirement account yet, that should be your number one priority.

• Headstands: I recently did my first unassisted headstand in yoga and I just wanted everyone to know that. Gratifying to improve at something and gain new skills as an adult! Up next: A forearm stand…

• Reading slump update: My friend Kristen recommended the Dungeon Crawler Carl series and while I really did not like it at first I am currently in the middle of the third book after starting the series about a week ago. I still don’t know if I “like” it but I’m invested!

• Recipe: I used my friend’s instant pot to make black beans (I had some of the Rancho Gordo midnight black beans) and I was pleasantly surprised with how they turned out. I’d probably add some more spices next time.

• Song: Lucy Dacus on one of my favorite Madi Diaz songs—lovely.

That’s it for now. See ya soon,
A

P.S. Thanks Christopher Skinner for the illustrations!