If you’re new to investing, you might want to compare brokerage accounts vs IRA accounts to decide where to invest.
After all, you can invest in stocks and other securities in either account—so what’s the difference? You will get to find out.
Keep reading this article on IRA vs Brokerage Accounts.
What is a Brokerage Account?
A brokerage account is the type of account used to buy and sell securities such as stocks, bonds and mutual funds. You can set up a brokerage account at a range of licensed brokerage firms — from pricier full-service stockbrokers to low-fee online discount brokers.
You can transfer money into and out of your account much like a bank account, but unlike banks, brokerage accounts give you access to the stock market and other investments.
You’ll also see brokerage accounts referred to as taxable accounts, because investment income within a brokerage account is taxed as capital gains.
This is in contrast to retirement accounts (such as IRAs), which have different tax and withdrawal restrictions and may be preferable for retirement savings and investing.
Many brokers allow you to open a brokerage account quickly online, and you generally do not need a lot of money to do so — in fact, many brokerage firms allow you to open an account with no initial deposit.
However, you will need to fund the account before you purchase investments. You can do that by transferring money from your checking or savings account, or from another brokerage account.
You own the money and investments in your brokerage account, and you can sell investments at any time. The broker holds your account and acts as an intermediary between you and the investments you want to purchase.
There is no limit on the number of brokerage accounts you can have, or the amount of money you can deposit into a taxable brokerage account each year. There should be no fee to open a brokerage account.
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What is an IRA?
An individual retirement account (IRA) is a savings account with tax advantages that individuals can open to save and invest in the long term.
Like a 401(k) account that an employee obtains as a benefit from their employer, an IRA is designed to encourage people to save for retirement. Anyone who has earned income can open an IRA and enjoy the tax benefits these accounts offer.
You can open an IRA through a bank, an investment company, an online brokerage, or a personal broker.
Anyone with earned income can open and contribute to an IRA, including those who have a 401(k) account through an employer.
The only limitation is on the combined total that you can contribute to your retirement accounts in a single year while still getting the tax advantages.
When you open an IRA, you can choose to invest in a wide range of financial products, including stocks, bonds, exchange traded funds (ETFs), and mutual funds.
Self-directed IRAs (SDIRAs) allow investors to make all of their own decisions and give them access to a wider range of investments, such as real estate and commodities. Only the riskiest investments are off-limits.
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Types of IRA
There are several kinds of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Each has different rules regarding eligibility, taxation, and withdrawals. Individual taxpayers can establish traditional and Roth IRAs, and small business owners and self-employed individuals can set up SEP and SIMPLE IRAs.
An IRA must be opened with an institution that has received Internal Revenue Service (IRS) approval to offer these accounts. Choices include banks, brokerage companies, federally insured credit unions, and savings and loan associations.
Because IRAs are meant for retirement savings, there is usually an early withdrawal penalty of 10% if you take money out before age 59½.
There are some notable exceptions—withdrawals for educational expenses, for example, and for first-time home purchases, among others. If your IRA is a traditional account rather than a Roth account, you will owe income tax on an early withdrawal.
Following is a breakdown of the different types of IRAs;
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In most cases, contributions to traditional IRAs are tax-deductible. So if you put $4,000 into an IRA, your taxable income for the year decreases by that amount. Then, when you withdraw the money in retirement, it is taxed at your ordinary-income tax rate. In that way, your money grows on a tax-deferred basis in a traditional IRA.
For 2021 and 2022, the annual individual contributions to traditional IRAs cannot exceed $6,000 in most cases. If you are 50 or older, you can contribute up to $7,000 per year (the extra $1,000 is considered a catch-up contribution).6
Your traditional IRA contributions are also fully deductible if you don’t have a workplace retirement plan.
If you (or your spouse, if married) have a 401(k) or 403(b) plan at work, your modified adjusted gross income (MAGI) influences whether and how much of your conventional IRA contributions can be deducted.
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Roth IRA contributions are not tax-deductible, but qualified distributions are tax-free. You contribute to a Roth IRA using after-tax dollars, but you do not have to pay any taxes on investment gains.
When you retire, you can withdraw from the account without incurring any income taxes on your withdrawals. Roth IRAs also do not have required minimum distributions (RMDs).
If you don’t need the money, you don’t have to take it out of your account. You can still contribute to a Roth IRA as long as you have eligible earned income, no matter how old you are.
Roth IRA contribution limits for 2020 and 2021 tax years are the same as they are for traditional IRAs. However, there is a catch. There are income limitations for contributing to a Roth IRA.
The phaseout range for single filers is between $125,000 and $140,000 in 2021 and $129,000 and $144,000 in 2022. For married couples filing joint taxes, the phase-out range is $198,000 to $208,000 in 2021, and $204,000 to $214,000 in 2022.
In 2021, you can only contribute the entire amount to a Roth IRA (but not to a traditional IRA) if your income is less than $125,000 for single taxpayers or $198,000 for married filers filing jointly.
These limits increase for the 2022 tax year when the phaseout begins at $129,000 for single filers and $204,000 for married couples filing jointly.
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Roth IRA vs Brokerage Account
Roth IRAs are retirement accounts that give investors valuable tax benefits. As long as you meet the requirements of the Roth IRA, any income or gains on the investments you make within the Roth are tax-free when you withdraw money in retirement.
That’s much different from what traditional IRAs offer, because even though your money in a traditional IRA grows on a tax-deferred basis, you still have to pay tax on withdrawals when you take the money out after you retire.
Yet many people choose not to open Roth IRAs. Because you can’t deduct a Roth IRA contribution from your taxable income for the year in which you contribute money to the retirement account, Roths don’t offer the same upfront tax savings as traditional IRAs.
In general, using a Roth is a better choice when you’re in a low tax bracket, while choosing a traditional IRA is more lucrative when you’re in a high bracket and can therefore see a lot of tax savings from the deduction for contributions.
However, the benefit of having a Roth IRA brokerage account is that you can invest in a much wider variety of different investments.
Because any gains are tax-free, your goal with a Roth IRA should be to grow your account balance as much as possible. By letting you invest directly in the stock market, many investors find that easiest to do in a brokerage account.
Furthermore, rather than margin accounts, Roth IRA brokerage accounts should be set up as cash accounts.
The reason: IRS regulations don’t allow you to invest borrowed money in a Roth IRA, so a margin account would potentially violate the Roth IRA rules and threaten the tax benefits that you get from it.
As a result, certain investing strategies that rely on having margin capacity available don’t work in Roth IRAs. Examples include short-selling stocks or opening certain types of positions in options contracts.
Differences between IRA and Brokerage Account
When you are engaged in financial planning, it is important for you to compare a brokerage account to an IRA. If you want to invest in the stock market, it is important for you to have a brokerage account.
These are taxable accounts that you open at a brokerage firm. After opening your account, you can then place buy and sell orders for stocks. Brokers then fulfill the orders for the investor and might charge fees in exchange for doing so.
Financial planning takes into account all of your financial goals. An IRA is important for long-term retirement goals while a brokerage account is good for short-term growth and long-term wealth-building.
While you can enjoy tax-deferred growth in an IRA or tax-free growth in a Roth IRA, a brokerage account lets you contribute unlimited amounts of money and to declare capital losses when you sell securities.
When you compare a brokerage account to an IRA, you might determine that opening both types of accounts might offer you the greatest benefits.
Types of Brokerage and IRA Accounts
There are several different types of brokerage and IRA accounts. A brokerage account to IRA comparison should incorporate the different types of accounts so that you can make the choices that can benefit you the most.
Types of IRAs
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
Three of the IRAs, including 401(k) accounts, SEP IRAs, and SIMPLE IRAs, are retirement accounts that you can get through your employer or open for yourself if you are an entrepreneur.
Types of Brokerage Accounts
- Cash Account
- Margin Account
- Options Account
A margin account is a type of financial account in which you must eventually pay for the securities that you purchase in full.
However, your broker extends a loan to you to purchase securities at the time of your purchase, and the securities in your account will serve as collateral for the loan.
An options account is a type of account in which you can invest in options. An option is a type of derivative that might be sold through a broker.
An options contract gives an investor the right to purchase or sell an underlying asset at an agreed price by a specific date. The date is referred to as the strike date.
How IRAS and Brokerage Accounts Are Set Up
To set up an IRA account, you can take the following steps:
- Choose the type of IRA account that you want such as a traditional IRA or a Roth IRA;
- Pick the financial institution that will serve as a trustee of your account;
- Pick the type of fund or customize your portfolio;
- Choose your investments; and
- Open your account and fund it.
A brokerage account compared to an IRA can be set up as follows:
- Decide what type of account you need
- Compare the costs
- Look at the services that are offered
- Pick your brokerage firm
- Complete the application
- Fund your account
- Research and choose your investments
IRAs have contribution limits that differ depending on the type. If you have a traditional or Roth IRA and are under age 50, you can contribute a maximum of $6,000 per year. If you are over age 50, you can contribute another $1,000 per year as a catch-up contribution for a total of $7,000.
Brokerage accounts do not have any contribution limits. This means that you are able to make unlimited contributions to these taxable accounts.
Withdrawals, Distributions, and Penalties
When you compare a brokerage account to an IRA, there are different rules regarding withdrawals, distributions, and penalties as follows:
- Traditional, SEP, SIMPLE, and 401ks- Early withdrawal penalties of 10 percent if younger than age 59 1/2
- Roth IRAs- Early withdrawal penalties of 10 percent, but some withdrawals are exempt
- Brokerage- Can withdraw money at any time without paying a penalty
If you have a traditional, SEP, or SIMPLE IRA, you will have to start taking mandatory minimum distributions after you reach age 70 1/2.
Roths and brokerages do not have required minimum distributions, and you can continue making contributions to these two types of accounts for as long as you want.
Financial planners recommend having both accounts, if possible. You can use a brokerage account for day trading, long-term investing, and to save for short-term financial goals, while an IRA is intended for retirement savings.
Brokerage accounts offer more flexibility, and there are no limits on contributions, withdrawals, or income to fund one.
IRAs, on the other hand, have lower annual contribution limits, withdrawals may trigger a penalty, and if your income is too high, you might not be able to contribute.
With a Roth IRA, contributions are not tax-deductible, but qualified withdrawals in retirement are tax-free (even for earnings). Traditional IRA contributions are tax-deductible, so you could save money at tax time for the year you contribute. But you will owe income taxes on withdrawals in retirement—including on all that growth.
That depends on the brokerage firm. Many brokers today offer very low minimum deposits (e.g., even zero) to get started. Of course, you will need to deposit at least $2,000 if you want to enable margin trading.
While you can open an IRA at a bank or brokerage firm, you will have more investment options—and higher potential earnings—at the latter. Banks tend to offer very limited, low-yield investment options, such as savings accounts and certificates of deposit (CDs).
Investors who can identify their life goals and have an investing strategy can justify using both an IRA and a brokerage account – getting the benefits both services provide.
Taxable brokerage accounts are ideal if you want to save for something but need to access the money before you reach retirement age. Whether you’re saving for a down payment on a house or funding a wedding, taxable brokerage accounts offer the growth and flexibility to help you reach your goal.
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