What is a brokerage account?

Key points

• A brokerage account is a financial account where you can invest in securities.
• Brokerage accounts can be taxable or nontaxable.
• You can have both nonretirement and retirement brokerage accounts.

You’ll probably need a brokerage account if you want to start investing.

Brokerage accounts are where you keep your investments. It’s kind of like using bank accounts to keep your cash. Of course, you can also have cash in a brokerage account, but that’s not the purpose of a brokerage account. 

What can you do with a brokerage account?

A brokerage account is a financial account for investing. You can own many types of investments in brokerage accounts, such as stocks, bonds and funds. Mutual funds and exchange-traded funds are baskets of dozens or even thousands of securities that make great starter investments in a new investor’s brokerage account.

Brandon Reese, president at TBS Retirement Planning in Hurst, Texas, says brokerage accounts are used by both self-directed individual investors who want to manage their investment portfolios and financial professionals managing client assets. 

There are a few things you can do with a brokerage account.

• Invest in stocks, bonds, mutual funds, ETFs, or publicly traded investments.
• Save for major financial goals like retirement, college, a downpayment, or even that big vacation you’ve been dreaming about.
• Get a higher return on your money than a traditional savings account.

How does a brokerage account work?

Brokerage accounts sound more intimidating than they are in practice. In reality, they work much like traditional bank accounts.

“You can merely go to any online broker like E-Trade, Scottrade, Fidelity, TD Ameritrade (or) Schwab and open an account,” says Daniel Milan, managing partner and investment advisor representative at Cornerstone Financial Services in Southfield, Michigan. The application process generally takes 10 minutes or less and requires no initial deposit, although you will need to fund the account to buy investments.

Funding your account is also simple if you already bank online. You can just transfer money from your bank account. 

You can also move money from an old retirement account into a brokerage account, provided the retirement account is also a brokerage account. In either case, the brokerage firm you open your account with will walk you through the funding process. 

Unless you elect to get financial guidance on your account, “You’ll be in charge of making your own investment decisions from asset allocation, fund selection, timing of buying (and) selling and tax management,” says Julie Virta, a senior financial advisor with Vanguard.

But many brokerage firms provide tools, such as automatic investment capabilities and educational resources, to make this process easier for investors. You can be self-directed with some guidance if you need it.

Choosing the best brokerage account for you

Selecting the best one comes down to two questions: 

1. What provider do you want to use? 
2. What’s the purpose of the account?

For the first question, you have two types of providers to consider: traditional firms and robo-advisors. You’ll generally have access to a broader investment selection through a brokerage firm than a robo-advisor, but robo-advisors can provide lower-cost guidance. 

Many of the major brokerage firms also provide robo-advisory services with competitive pricing.

When shopping for a brokerage account provider, keep the following in mind:

• Cost. Lower is better unless you feel the extra service you’re getting is worth the higher fee. Different brokerage accounts have different fees for transactions, says Stuart Boxenbaum, a certified financial planner and president of Statewide Financial Group in Jupiter, Florida. Ideally, the only fees you pay are for the investments you use or advice you receive. 
• Investment options. More isn’t always better. If you’re prone to analysis paralysis or know you just want the basics, a provider that caters to that may be your best option.
• Guidance. What level of financial advice do you want? If you want to work with a human advisor, do you want to be able to meet this person face to face?
• Education and research. Brokers have different levels of education and research available. For example, a robo-advisor may have a strong educational platform but not as many research capabilities since you’ll be expected to use their prebuilt portfolios.

Now to answer the second question: Once you’ve decided where to open your brokerage account, you’ll need to determine what type of account to open.

“Brokerage accounts are usually classified by their tax status,” Boxenbaum says. In taxable brokerage accounts, your investment earnings are taxed the year you receive them. For example, if you sell shares of a stock in 2023 for a $100 profit, you’ll need to pay taxes on that profit for that tax year.

“People often use taxable brokerage accounts for goals that are not retirement or education-based, although many also use taxable brokerage accounts as supplementary retirement (or) education accounts after they’ve maxed out their other tax-advantaged accounts,” Virta says. “This could include saving for a home, car, vacation, or other goals.”

With nontaxable brokerage accounts, such as traditional individual retirement accounts, or IRAs, you don’t pay taxes on your earnings until you withdraw them. If you sell a stock for a $100 profit inside your IRA in 2023 but don’t take the money out of the account that year, you don’t have to pay taxes. If you withdraw the money in 2024, you’ll pay taxes for that tax year.

Brokerage account vs. retirement account

There are two types of nontaxable retirement brokerage accounts: traditional or pretax, accounts and Roth, or after-tax accounts. Traditional retirement accounts are funded with pretax dollars. The money goes straight from your paycheck into the account, as in a 401(k), or you get to take a tax deduction for your contribution, as in a traditional IRA.

In Roth accounts, contributions are made after taxes have been paid. You don’t get a tax cut today for money you put into a Roth, but the upside is that you don’t have to pay taxes later when you withdraw it.

The downside to this tax benefit is that the IRS limits how much you can put into retirement brokerage accounts. In 2023, the contribution limit for traditional IRAs, for example, is $6,500, or $7,500 if you’re 50 years or older. Your contributions also cannot exceed your earned income for the year. So if you only earn $5,000 in 2023, your IRA contribution is capped at $5,000.

You could face withdrawal restrictions with retirement brokerage accounts that are funded with pretax dollars, such as in the case of a traditional IRA. The IRS imposes an early withdrawal penalty of 10% in addition to the taxes owed if you take money out of a traditional retirement account before age 59½. That’s unless it’s for a certain hardship. The IRS  has rules on which withdrawals are exempt.

Roth IRAs are more flexible when you can withdraw money since the IRS taxed it before it went in. 

You can take out any money you put in if the account is at least five years old. But you can’t withdraw the earnings in the account until age 59½ without incurring a 10% penalty. There are exceptions when you can withdraw money from an IRA before age 59½ without a penalty, such as for a qualified first-time home purchase or if you become permanently disabled. A full list of exceptions is available on the IRS website.

Given these restrictions, Virta recommends earmarking any funds in a retirement account for long-term goals like retirement.

If you’re having trouble deciding between a taxable brokerage account and a retirement account, have no fear: You don’t have to choose. The best course of action is usually to open both to diversify the types of accounts you hold.

“Having a brokerage account that’s taxable, a traditional pretax IRA or Roth IRA gives you the flexibility to choose your tax liability from year to year,” Reese says.

If you do choose both, Virta recommends funding your tax-advantaged accounts first. 

“Retirement accounts like an employer-sponsored 401(k), traditional IRA and Roth IRA offer notable tax benefits and other features investors will want to take advantage of — from tax-free growth through a Roth IRA or the ability to take advantage of an employer match, aka free money, through your 401(k),” she says.

Here’s a breakdown of the differences between a nonretirement brokerage account and a retirement account:

Types of brokerage accounts

Separating brokerage accounts into only retirement and non-retirement is just the outside of the umbrella. Within the umbrella of non-retirement brokerage accounts are many other types of accounts you’ll have to choose when you open a brokerage account.

Non-retirement brokerage accounts are first classified by who owns the account:

Individual brokerage accounts. Owned by one individual.

Joint brokerage accounts. Owned by two or more individuals.

Custodial accounts. Owned by an adult for the benefit of a minor who will take ownership when they reach 18 or 21 (depending on the state).

Trust brokerage accounts. Owned by a trust with designated trustees who can decide how the money within the account is handled.

There are also several types of joint brokerage accounts. Each handles ownership differently when one of the owners dies:

Joint tenants with rights of survivorship. This means that the surviving owner(s) will automatically receive the decedent’s share of the account.

Tenants in common. This means that the decedent’s share goes to their estate, not the other owner(s).

Community property accounts. Owned by married couples, the decedent’s share goes to the surviving spouse’s estate.

If you’re not sure which type of brokerage account to open, don’t worry. You can always change the registration later. Your brokerage firm will help you through the process.

A final kind of brokerage account to know about is margin accounts. 

In a margin account, you can borrow money to trade. The brokerage firm is effectively loaning you money with your existing account assets as collateral. Trading on margin is highly risky because you could lose more than what you initially invested. It’s best to steer clear of these accounts unless you’re confident you understand all the risks.

Tip: Regardless of the type of account you open, make sure you take the time to add beneficiaries. To avoid probate, Reese says to list beneficiaries on all retirement accounts and use the “transfer on death,” or TOD, a designation for beneficiaries on nonretirement accounts.

Frequently asked questions

What can I do with a brokerage account?

Brokerage accounts let you invest your savings to grow them over time. You can use a brokerage account to save for any financial goals, from college to retirement, a down payment on a house or even a big vacation.

Can I have multiple brokerage accounts?

You can have as many brokerage accounts as you’d like, as you can have multiple bank accounts. 

A word of warning, however: Too many accounts can become a management headache as you must keep track of them and evaluate how the investments work together toward your larger financial goals. This becomes especially challenging if you have accounts with different brokerage firms or providers.

Are brokerage accounts safe?

Investments in many brokerage accounts are covered by Securities Investor Protection Corp. insurance, which is effectively the investment equivalent of FDIC insurance that covers bank deposit accounts. SIPC covers up to $500,000 of the value in a brokerage account, including $250,000 of cash held in the account, if the brokerage firm fails. 

This is the key point: SIPC insures your assets against the brokerage firm’s failure; it does not protect you against investment losses. Your investments can still lose value. That’s just the nature of investing.

It’s also important to note that not all brokerage accounts have SIPC insurance, so be sure to check before opening an account.