Infographic: How is a brokerage account taxed?
Brokerage accounts (also called non-qualified accounts) are taxed differently than qualified retirement plans like a 401(k) or a 403(b). If you aren't sure what to do with extra savings each month or have already maxed out your 401(k) and want another way to invest, consider using a brokerage account.
There can be a number of benefits to using a brokerage account to invest. Even there are no tax benefits in the short term, a dedicated approach to investing in this type of account over the long term (in addition to your retirement plan at work) may be able to help offset the so-called retirement tax cliff.
How a brokerage account can provide tax planning opportunities in retirement
There is a common misconception that retirees will invariably be in a lower tax bracket than they were during working years. Although this can certainly be the case, some retirees with a significant portion of assets in tax-deferred accounts (like a 401(k)) find themselves in a much higher tax bracket once Required Minimum Distributions begin at age 70 1/2.
Withdrawals from a tax-deferred retirement plan are taxed as ordinary income, which can be problematic when you have fewer options to reduce your taxable income, as many retirees later find out. A brokerage account isn't the only option for investors, however. At any income, individuals can make one Roth IRA conversion each year. A Roth IRA can also help retirees with tax planning alternatives, potentially avoiding the retirement tax cliff altogether.