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WalletPrep worksheet · Investing

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

Name ____________________ Date __________

Key ideas

  1. A brokerage account has no tax break. You put in money that was already taxed, and you owe tax on dividends and on gains when you sell.
  2. Holding over one year lowers the tax. Gains on investments held more than 1 year are taxed at 0%, 15% or 20%. Shorter holds are taxed like your paycheck.
  3. SIPC covers a failed firm, not losses. If the brokerage itself fails, SIPC covers up to $500,000 per customer. Market drops are never covered.

Vocabulary

Brokerage account
An investment account where you can buy and sell stocks, bonds, ETFs and mutual funds. It has no special tax benefits.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Index fund
A mutual fund or ETF that tries to match a market index by holding the investments in it, rather than picking winners.
Bond
A loan you make to a government or company. It pays you interest and returns your money on a set date, called the maturity date.
Contribution limit
The most you can put into a tax-advantaged account in a year. The IRS sets the limits and often raises them.
Dividend
A payment a company makes to its shareholders out of its profits, usually in cash and often every 3 months.

Work it out

Dev bought $4,000 of a broad index fund in his brokerage account. Three years later it is worth $5,200, and he sells it all for a car. Assume a 15% long-term rate.

  1. Sale price
  2. What he paid (cost basis)
  3. Long-term capital gain
  4. Tax rate (assumed)
  5. Sale price
  6. Tax at 15% of the gain
  7. Dev keeps

Check yourself

  1. What does SIPC protection cover in a brokerage account?

    • A. Losses when the stock market falls
    • B. Missing assets if the brokerage firm fails
    • C. Bad advice from a broker
    • D. Losses on cryptocurrency

  2. You buy shares for $2,500 and sell them 2 years later for $3,100. What is your capital gain?

    • A. $3,100
    • B. $2,500
    • C. $600
    • D. $560

  3. Which is true of a regular brokerage account?

    • A. You can withdraw money at any age without a penalty
    • B. It has a yearly contribution limit like an IRA
    • C. Gains inside it are never taxed
    • D. Deposits are insured by the FDIC

Your turn

Check that your 401(k) match and emergency fund are covered. If they are, look up one online brokerage on FINRA BrokerCheck, read its fee schedule, and open an individual cash account. Link your bank, and set a small monthly transfer and automatic index fund purchase.

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Answer key

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

Work it out

  1. Sale price$5,200
  2. What he paid (cost basis)− $4,000
  3. Long-term capital gain= $1,200
  4. Tax rate (assumed)15%
  5. Sale price$5,200
  6. Tax at 15% of the gain− $180
  7. Dev keeps= $5,020
  1. His gain is $5,200 − $4,000 = $1,200. Tax is owed only on the gain, not on the $4,000 he put in.
  2. He held it more than 1 year, so it is a long-term gain. At 15%, the tax is $1,200 × 15% = $180, and he keeps $5,200 − $180 = $5,020.
  3. Had he sold within a year with a 22% income tax rate, the tax would be $1,200 × 22% = $264. Waiting past one year saved him $264 − $180 = $84.

Check yourself

  1. B. Missing assets if the brokerage firm fails SIPC steps in when a brokerage firm fails and customer assets are missing. It never covers a drop in the value of your investments.
  2. C. $600 Gain = sale price minus cost basis: $3,100 − $2,500 = $600. You held more than 1 year, so it is a long-term gain.
  3. A. You can withdraw money at any age without a penalty A taxable brokerage account has no age rules or contribution limits. The tradeoff is that dividends and gains are taxed, and investments are not FDIC insured.