What is a brokerage account and how do you open one?

A brokerage account is an investment account you open with a brokerage firm to buy and sell stocks, bonds and funds, with no contribution limit and no age rules for taking money out. You can open one online in about 15 minutes, but you pay tax on gains and dividends each year, so most people fill their 401(k) match and IRA first.

It is flexible but taxable

A regular brokerage account, often called a taxable account, has no yearly contribution limit, no income limit and no penalty for taking money out at any age. In exchange, there is no tax deduction going in and no tax-free growth.

You pay tax on what you earn

Dividends and interest are taxed in the year you get them, even if you reinvest them. When you sell something for more than you paid, the profit is a capital gain, and you owe tax on it for that year.

Order matters for most people

A common order is the full 401(k) match, an emergency fund, paying off high-interest debt, then an IRA. A brokerage account is the next place for long-term money, or for goals 5 or more years away that are not retirement.

Protection is limited

Investments are not FDIC insured. SIPC protects up to $500,000 per customer, including $250,000 in cash, if the brokerage firm fails and your assets are missing. It does not cover losses when prices fall.

What a brokerage account is

A brokerage account holds investments for you. You move money in from a bank account, then use that cash to buy stocks, bonds, exchange-traded funds or mutual funds. The firm keeps track of what you own and sends you statements and tax forms.

The word brokerage covers several account types. An IRA held at a brokerage firm is still an IRA, with its tax rules. When people say "a brokerage account" on its own, they usually mean the regular taxable kind with no special tax treatment, and that is what this lesson covers.

How it compares with a 401(k) or IRA

A 401(k) and an IRA give you a tax break, either now (traditional) or later (Roth). In return they cap how much you can put in each year and charge a penalty, with some exceptions, if you take money out before age 59½.

A brokerage account flips that trade. You can put in any amount and take it out anytime, but you get no deduction and you pay tax on dividends and gains along the way. That makes it a good second step for money you won't need for at least 5 years but may want before retirement, like a house fund that is still a long way off.

How to open one

Opening an account online takes about 15 minutes. You'll give your name, address, date of birth, Social Security number and employment details, because brokerages are required by law to verify who you are. You'll also be asked about your income, goals and how much risk you are comfortable with.

Pick an individual account (or a joint account with a partner), and choose a cash account rather than margin. Then link your bank account. The first transfer usually takes 1 to 3 business days to arrive, and the cash sits in the account until you buy something with it.

Before you pick a firm, look at its fee schedule and check it on FINRA BrokerCheck. Many online brokerages charge nothing to open an account or trade most stocks and funds, but fees for paper statements, inactivity, wires and transferring out still exist at some firms.

What to buy once it is open

Money that lands in a brokerage account is not invested yet. It usually sits as cash, sometimes swept into a bank deposit or a money market fund, until you place an order. A common mistake is to deposit money and stop there.

For most beginners, one broad, low-cost index fund that holds thousands of companies is enough. You can set up an automatic monthly transfer and an automatic purchase so each paycheck buys more shares without you deciding each time.

How the taxes work

Your brokerage sends you Form 1099-DIV for dividends and Form 1099-B for sales each year. You report both on your tax return. Dividends that meet IRS rules for qualified dividends are taxed at the lower capital gains rates.

When you sell, the gain is what you sold for minus what you paid, called your cost basis. Investments held 1 year or less produce short-term gains, taxed at your regular income tax rate. Investments held more than 1 year produce long-term gains, taxed at 0%, 15% or 20% depending on your taxable income. If you sell at a loss, the loss can offset gains.