5 Smart Tax Moves for your Brokerage Account

by Joe Allaria | Oct 19, 2020

Whether you acquired a brokerage account via inheritance, divorce, or simply contributing over time, a brokerage account combines the growth potential of stocks and mutual funds with the liquidity of a savings account. However, while growth can be a good thing, it can also cause unintended tax consequences in the form of dividends and capital gains tax.

Stocks held for less than twelve months and sold at a profit result is short-term capital gains, which are taxed as ordinary income. Stocks held for longer than twelve months and sold result is long-term capital gains (commonly taxed at 15%).

If your brokerage account is of significant size, those become even bigger problems. In fact, a brokerage account can become, in some ways, a metaphorical ticking tax time bomb.

The good news is that there are ways to diffuse that tax time bomb. Below are five tax-savvy moves you can make with your brokerage account.

1. Contribute To Your Roth IRA

If you have earned income and your income is below IRS limits, you can move money from your brokerage account to a Roth IRA. One reason you should consider this move is that your contributions are made on an after-tax basis and any earnings in your Roth IRA would be tax free, assuming you meet the rules for qualified withdrawals (see www.irs.gov).

The annual Roth IRA contribution limit is $6,000/year for 2020 ($7,000/year if you are 50 or older). And remember, you only need enough earned income to cover the contribution amount. Therefore, the source of the contribution can be your savings account, checking account, brokerage account, etc.

2. Contribute To Your 401(k)

If you are an active participant in a retirement plan, there could be a couple advantages to using your brokerage account to increase your 401(k) contributions, including increased employer matching and an immediate reduction in your income taxes.

Unlike contributing to your Roth IRA, the source of your 401(k) contributions does matter. These contributions must come from salary deferrals (through your employer’s payroll). However, if you increase your salary deferrals and are short on income, you can use your brokerage account as a “paycheck substitute.”

Your plan might allow for Roth 401(k) contributions as well, which cannot be hindered by income limits. For either Roth or Traditional 401(k) contributions, you can contribute up to $19,500/year as of 2020 ($26,000 for those 50 and older).

As with a Roth IRA, a 401(k) is a retirement account and thus, places additional restrictions on early withdrawals (prior to 59 ½). Carefully evaluate your options to make sure you have enough liquid savings before you contribute to restrictive retirement accounts.

3. Contribute To An HSA

HSAs (Health Savings Accounts) provide tax deductibility for contributions, but also provide for immediate tax-free withdrawals (if withdrawals are used for qualified medical expenses), making them a solid option. But, if you never use your HSA for qualified medical expenses, you can still withdraw HSA funds at age 65 or older and only pay ordinary income tax (like a pre-tax IRA).

The catch to contributing to an HSA is that you must have a high-deductible health insurance plan. However, just having access to an HSA is not a good enough reason to choose a high-deductible health insurance plan. You need to carefully evaluate what’s best for you and your family before you choose your plan.

4. Give To Charity

If you are charitably inclined, consider gifting shares of appreciated securities to your charity of choice instead of cash. By gifting shares of appreciated securities, or securities that have gone up in price, you can avoid triggering a gain on the sale of the security. if you have held the security for longer than one year, you can also receive donation credit for the market value of the security on the date of the gift, which could allow you to itemize your deductions.

Also, since charities are tax-exempt, they will avoid having to pay capital gains tax if they choose to sell the position, creating a win-win for both parties.

5. Contribute To A 529 Plan

Like the other options listed, a 529 College Savings Plan offers tax-preferred treatment. Contributions may be deductible on the state level and qualified withdrawals can be taken tax-free (as long as they are used for approved education expenses (see www.irs.gov).

Bottom Line

Too often, we think we must contribute to these tax-advantaged accounts from our regular cash flow. However, this is just not the case. If you have acquired or built your own brokerage account, it might be time to start using it in a more tax-efficient manner.

As always, you must understand how to navigate the rules of each of these strategies listed. The IRS provides for ways to receive tax-preferred treatment, but one wrong move could result in a large tax bill. Seek advice from a qualified tax or investment professional for help.