Broker accounts can be taxed depending on the type of account.
There are three main types brokerage accounts: traditional retirement accounts, Roth retirement accounts and taxable retirement intermediary accounts. Each type of account has a different tax treatment.
Pension accounts are deferred for taxes, which means you don’t pay income tax on the account. Instead, you can raise debt when you withdraw money from your account. Brokerage accounts for retirement — also called taxable brokerage accounts — do not have the same deferred tax advantage. On those accounts, “investment earnings and capital gains are taxable income of account holders in the calendar year in which this occurs,” says Jeff Craig, senior wealth advisor and director of The Colony Group.
How are brokerage accounts taxed?
When you make money in a taxable brokerage account, you must pay tax on that money in the year it was received, not when you withdraw it from the account. This earnings can come from capital gains, dividends or interest.
“When you sell a security as a stock more than you bought it, the difference is taxed as a capital gain,” Craig says. For example, if you bought a stock for $ 100 and then sold it for $ 150, you will owe tax on $ 50 of capital gains. How much tax you owe will depend on how long you have kept the investment.
“If you have held the investment for a year or less, which is called short-term capital gains, you are taxed at the usual income tax rate,” says Matthew Erker, a certified public accountant, chartered financial planner and advisor at Moneta, a registered investment advisory firm owned. partner. “However, if you have held an investment for more than a year, which is called long-term capital gains, you are taxed at a lower capital gains tax rate.”
[READ: What Is a Roth IRA?]
Both your usual income tax rate and the capital gains tax rate depend on how much income you earn in a year. “There are seven different regular income tax classes ranging from 10% to 37%, and three different income tax rates ranging from 0% to 20%,” says Erker. Because the difference between the usual income tax rate and capital gains tax can be significant, he says it’s important to think carefully before you sell a property you own for less than a year.
Taxpayers with modified adjusted gross income of more than $ 200,000 for single people, more than $ 250,000 for joint filing, or more than $ 125,000 for joint marriage claims may owe 3.8% tax on net investment income earned during the year on top of their regular income or capital gains tax, Craig says.
Dividends received during the year are also taxed in the year in which they are received when the security is held in a taxable brokerage account. The way dividends are taxed depends on whether they are qualified or ordinary unqualified dividends. Ordinary dividends are taxed at normal income rates, while eligible dividends that meet certain IRS standards are taxed at lower rates. These standards include that you have held the investment for more than 60 days and that the dividend is paid by a U.S. corporation or a qualified foreign corporation. For more information on qualifying dividends, see IRS Publication 550.
“If the dividend is eligible, it’s subject to the same tax rates as long-term capital gains — 0%, 15%, or 20% depending on your income,” Craig says.
Interest is another type of taxable investment income. “Interest can be earned on cash and fixed-income securities, such as bonds or bond mutual funds,” Craig says. Interest income is generally taxed as ordinary income.
With pension accounts, taxation is a little easier. Traditional pre-tax dollar-funded pension accounts are not taxed until the money is withdrawn from the account. You can make as many capital gains, dividends or interest in your account without having to pay taxes. But you will have to pay a regular income taxes to any money you withdraw from the account in the year in which you make the distribution.
Roth dollar-financed post-tax pension accounts can be “non-taxable,” says Craig. Similar to traditional retirement accounts, you do not pay income tax on earnings or capital gains received at Roth, and if you meet certain conditions, such as an account that you have had an account for at least five years, you will not have to pay tax when you withdraw money. This can make Roth accounts a great tool for reducing investment taxes.
How to reduce taxes on brokerage accounts
There are strategies that investors can use to reduce taxes on brokerage accounts.
It is most obvious to use deferred tax pension accounts whenever possible. Outside of retirement accounts, you can also reduce taxes by being strategic when selling investments. You can avoid a higher rate of short-term capital gains tax if you do not sell the invested funds if you do not keep them for more than a year.
Another strategy is to use tax loss collection where you take capital losses based on investments to recoup capital gains. “If you sell a security at a price less than your price, you have a capital loss,” Craig says. “You can use capital losses to reduce capital gains, and if your losses exceed your gains, you can use up to a $ 3,000 loss to reduce ordinary income.” He suggests that you review your portfolio every year opportunities to collect tax losses.
“If the market or a particular investment is in decline, consider selling the property and buying similar property immediately,” says Erker. “This ensures that you stay invested in the market and allows you to post a loss that you can use to offset future capital gains.”
You can also use tax-managed funds that focus on tax efficiency and can collect tax losses as part of your strategy, while avoiding companies that pay dividends, Craig says.
All of this said, “While the tax implications are extremely important to consider every time you sell a property, they don’t necessarily lead to investment decisions,” says Erker. “If you are unable to use any strategy to alleviate the tax burden, but it makes sense to sell the property, do so and accept the tax hit.”