Brokerage Accounts & Wealth-Building

Investing confounds many people. They feel overwhelmed by all the acronyms [401(k), IRA, Roth IRA, ETF, etc.] and fearful of making an irreversible mistake. They often feel incapable of making any investing decisions because of a lack of financial literacy. This is why we see so many new clients come to us with large cash positions. Unlike establishing and maintaining 401(k) plans, investing outside an employer plan requires individuals to make significantly more decisions about which investments to choose, and many people feel they are unequipped to make those decisions. Here are a few reasons brokerage accounts are so impactful in your wealth-building journey. ?

1. They are extremely flexible.

From a tax-treatment perspective, brokerage accounts essentially function as savings accounts in that they do not offer any tax advantages (unlike an IRA or 401k). However, there are a few differences between brokerage and savings accounts:

• The funds can be invested. Investors have the opportunity to earn a higher rate of return than what a typical savings account offers.
• Investors may choose from the entire investing universe based on what their custodian offers.
• There are no age restrictions on when you can access the funds.
• Funds can move to and from these accounts easily.

All this means that while you may earmark brokerage account funds as supplemental retirement funds, they can be tapped into whenever you may need them—to pay off debt; fund a child’s education, a sabbatical, or home improvement projects.

2. They are a key tool when considering early retirement.

We often educate clients about the value of tax diversification, as it is one of the underrated tools of a sound financial plan. Tax diversification essentially means that a person owns assets that are treated differently from a tax perspective. This allows them to be flexible and nimble when selecting how they fund their retirement income needs. We have seen many retirees approach retirement with a substantial nest egg that is almost entirely held in a traditional 401k or IRA. Why do we consider this a problem? It is a problem because any dollar that is withdrawn from a traditional 401k or IRA is taxed at federal ordinary income tax rates. For some people, that can be as high as 37% (not to mention potential state income tax treatment). Unlike a traditional retirement account, any income earned in a taxable brokerage account is taxed at lower capital gains rates when the income is realized. In 2023, the highest federal capital gains tax rate is 23.8% (20% + 3.8% medicare surcharge). Without the age restrictions of traditional retirement accounts, there is an opportunity to have your money grow at a higher rate and be more tax-efficient upon withdrawal. Investors beware—if you sell a stock at a gain, that gain is taxable, even if you don’t withdraw the funds.

3. They are an asset you can leverage for liquidity.

Just like you would consider your home equity as an asset you can tap into for funding needs, I encourage folks to build brokerage accounts on their wealth-building journey and consider utilizing them as another funding source. A brokerage account can be leveraged as an asset, just like your real estate portfolio. Many custodians offer the option to establish a securities-based line of credit on your brokerage account. This means that you can borrow against the value of your portfolio at similar or oftentimes, lower interest rates than home equity lines of credit. You can, therefore, avoid liquidating investments and potentially incurring a tax bill as a result. In lower interest rate environments, the borrowing rate is typically lower than historical average market returns, meaning that even if one were to draw a line of credit against the value of their portfolio, they are potentially able to keep their money growing at a greater pace than the debt costs. As an example, let's say the annualized projected portfolio returns are 7.5% and the interest rate on the debt is 5.25%. In this example, it would likely make sense to keep the money invested and earn 7.5% while borrowing at a lower rate, essentially out-earning the cost of the debt by 2.25%.

4. They can supercharge mid-term savings goals.

For anyone saving for a large goal (5+ years away), it can be beneficial to invest those funds in a brokerage account. The growth you can achieve can hopefully allow you to reach your end goal quicker than if you had simply kept your deposits in a savings or money market account.

Overall, taxable brokerage accounts are one of three “buckets” of money that would be a wise addition to any financial plan. They potentially provide flexibility, growth, and efficiency in your wealth-building journey.

Your Team at Re-Envision Wealth

This material is intended for educational purposes only. You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. Nothing in this material constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Past performance does not guarantee future performance. Future returns may be lower or higher. Investments involve risk. Investment values will fluctuate with market conditions, and security positions, when sold, may be worth less or more than their original cost.