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It is always a good idea to keep an eye out for investment opportunities. With so many options available, it is easy to become overwhelmed.
This article will focus on the differences between an individual retirement account (IRA) and a brokerage account and help you decide which is best for your financial situation.
By the end of this article, you will know the ins and outs of both types of investment accounts, as well as their benefits and disadvantages. This article will give you all the information you need to select the correct arrangement for your future investment.
What is an IRA?
An IRA is a tax-advantaged retirement account that allows investors to save for their retirement and access various tax deductions. IRAs are often referred to as tax deferred.
There are two types of IRAs: traditional and Roth.
A Roth IRA allows you to invest after-tax dollars and withdraw the money tax-free. Roth IRA contributions are not tax deductible, but the money grows tax-free, and you can withdraw without tax implications.
After you get your paycheck, you can deposit some of your money into a Roth IRA. Since you have already paid taxes on this money, you don’t have to pay taxes again when you withdraw the money during your retirement.
Traditional IRAs are tax-advantaged accounts that allow you to save for retirement while accessing various tax deductions.
Contributions to a traditional IRA are deductible from your taxable income, meaning you get a tax break on the money you contribute, i.e., interest income is taxed as ordinary income.
The money is invested and grows over time, and when you begin to withdraw from it in retirement, the government taxes your withdrawals at your current tax rate.
Benefits of IRAs
Opening and investing in an IRA offer several benefits.
- Tax-free growth: As mentioned earlier, the money invested in IRA accounts grows tax-free. Tax-free growth means your investments are not taxed annually, and the account automatically reinvests all earnings without being taxed.
- Tax deductions: Traditional IRAs come with numerous tax benefits, including deducting your contributions from your taxable income.
- No capital gains taxes: When you sell investments in your IRA, you do not pay capital gains taxes.
- Flexibility: IRAs allow you to choose from various investments, including stocks, bonds, exchange-traded funds (ETFs), and mutual funds.
- No taxes on dividends: When you earn dividends within an IRA, the account automatically reinvests the dividends into your portfolio without being taxed.
Drawbacks of IRAs
Despite their advantages, IRAs also come with several drawbacks.
- Contribution limits: You are limited on how much you can contribute to an IRA each year. Contribution limits primarily apply to Roth IRAs, which the federal government caps at $6,500 or $7,500, depending on your age.
- Withdrawal penalties: Withdrawing from an IRA before you are 59½ years old can result in hefty penalties, so you should plan your retirement savings accordingly.
- Required withdrawals: Traditional IRAs have minimum distributions requirements, meaning you must withdraw a certain amount each year after you hit 70½ years old.
What is a Brokerage Account?
A brokerage account is a taxable account with a broker or a financial institution where you can buy and sell investments, such as stocks, bonds, mutual funds, and ETFs.
A brokerage account allows you to hold multiple assets in a single account and makes it easy to manage your portfolio.
Benefits of Brokerage Accounts
Brokerage accounts have many benefits and offer far more flexibility than IRAs:
- No contribution limits: Unlike IRAs, brokerage accounts do not have any contribution limits, meaning you can invest as much money as you want and make the most of your investments.
- Withdraw money anytime: With a brokerage account, you can withdraw anytime. However, you will have to pay taxes on withdrawals.
- Borrow money: Unlike IRAs, brokerage accounts allow you to borrow money for investments. Borrowing is a great way to leverage your assets and increase your returns.
- FDIC insurance: The FDIC insures your brokerage account up to $250,000, providing extra protection for your money. This insurance means that you will get your money back, even if your financial institution goes bankrupt.
- Investment options: Brokerage accounts offer many investment options, including stocks, bonds, mutual funds, and ETFs.
Drawbacks of Brokerage Accounts
Brokerage accounts provide you with far more flexibility than IRAs. However, you lose many of the tax advantages, and you have to pay additional fees.
- No tax advantages: Unlike IRAs, brokerage accounts do not have any tax advantages, which means you must pay taxes on any profits you earn from your investments.
- Capital gains taxes: When you sell investments in a brokerage account, you must pay capital gains taxes.
- Limited financial advice: Brokerage accounts typically provide little advice and guidance, making them not ideal for beginners.
- Commissions and fees: Brokerage accounts include additional costs, such as trading commissions and account maintenance fees.
Brokerage Account vs IRA: How do they compare?
To select the most suitable investment account for your finances, it is essential to look at the similarities and differences between an IRA and a brokerage account.
|No contribution limits||Tax-free growth|
|Withdraw money anytime||Contribution limits|
|Lots of investment options||Withdrawal penalties|
|Capital gains taxes||Required withdrawals|
Which is Better: IRA or Brokerage Account?
Now that you know the difference between an IRA and a brokerage account, it will be easier to decide which investment account is more suitable for you based on your desired outcomes and experience level.
- You want to benefit from tax advantages
- You’re comfortable with the contribution limits
- You are willing to commit to a long-term investment
- You want more flexibility
- You’re looking for more investment options
- You are comfortable with paying taxes on your investments
No matter which accounts you choose, creating a financial plan and finding a way to save for your future is essential. Investing can be confusing and overwhelming, but you can make the best decision with the proper knowledge and guidance.
Below are some common questions about IRA and brokerage accounts.
Should I have a brokerage account and an IRA?
Yes, having an IRA and a brokerage account is a good idea. Both accounts provide different benefits, so having both maximizes your options.
Is a traditional IRA better than a brokerage account?
A traditional IRA is better than a brokerage account if you want to invest in your retirement.
Can an IRA be held in a brokerage account?
Yes, many brokerage accounts allow you to have an IRA within your account.
Is there a minimum requirement to open a brokerage account?
Yes, most brokerage accounts require an initial deposit of at least $500. You must also be at least 18 years old.
If you are younger than this, you can have a guardian open an account that you can access when you are of age.