Brokerage account vs IRA and which should you invest in? | Investing 101

Saving for retirement is a long game.

While there are plenty of ways to save and invest your hard-earned money, you want to make sure you choose the best investment tools that are right for you.

You may be in a situation where you have maxed out your 401(k) and are considering other options like an Individual Retirement Account or a Brokerage Account that have unique features that can benefit your overall investment strategy .

Each account has different purposes. Generally speaking, a brokerage account is for investing in the stock market, while IRAs focus on retirement planning.

The different tax treatments of each type of account is what can ultimately sell an investor, given that the money is subject to tax at some point. Here’s what you need to know about IRAs and brokerage accounts that can help you invest effectively for the long term:

An IRA is a retirement investment vehicle that offers tax advantages for your retirement savings.

Investing in an IRA allows you to grow your money tax-free. This means that you will not pay tax on your investment returns at the current tax rate, but rather at the tax rate at the time the money is withdrawn, so the money grows free from tax. This allows your money to accumulate exponential growth.

For IRA contributions between 2019 and 2021, the total contributions allowed annually to traditional and Roth IRAs cannot exceed $6,000. If you are 50 or older, you are entitled to catch-up contributions and the maximum annual amount is $7,000.

Besides a traditional IRA, there are several other types of IRAs. A Roth IRA also allows your money to grow tax-free like a traditional IRA, but what’s different with a Roth is that investors can make tax-free withdrawals on contributions. A Roth has similar contribution limits to its traditional counterpart.

A Simplified Employee Pension IRA is a tax-deferred retirement plan for the self-employed. This is different from an Employee Savings Incentive Plan, or SIMPLE IRA plan, which gives employees and employers the option to contribute to the employee’s traditional IRA.

There is no income limit for a traditional IRA, although there is a contribution limit. For a Roth IRA, investors can only contribute the full amount if their adjusted adjusted gross income is less than $125,000 for 2021. Brokerage accounts have no restrictions on how much you contribute.

If you want to withdraw money from your IRA, you may incur withdrawal penalties when the money is withdrawn too soon. The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, authorized special distribution options for pension plans and IRAs and provided expanded lending options for eligible pension plans for those suffering economic hardship due to the pandemic. This coronavirus-related distribution was to be made from a qualifying retirement plan to a qualified person from January 1, 2020 through December 30, 2020, up to an aggregate limit of $100,000 from all plans and IRAs, according to the IRS.

Typically, with a traditional IRA, it takes 59.5 years to withdraw money without penalty; otherwise, you will incur a 10% penalty as well as federal and state fees. At age 59½, you can begin withdrawing money from your IRA without penalties, but you are subject to any taxes that may be due.

You can open an IRA with a bank or brokerage firm. Once you open your IRA, be sure to fund it with investments. You can choose mutual funds, exchange-traded funds, and individual securities, among many other investments.

“You can generally invest in the same securities in your IRA as you would at a taxable brokerage,” says Nikki Dunn, a Houston-based certified financial planner. Dunn explains that this gives people a wide range of investment options while taking advantage of tax deferral.

Choose investments that match your investor profile, risk tolerance, time horizon and overall investment goals. By contributing to your IRA at a consistent rate — either monthly, quarterly, or annually — this tax-efficient retirement account will eventually appreciate over time.

You can open an IRA with any starting amount as there is no account minimum. But depending on the investments you choose for your account, they may require a minimum dollar amount.

A brokerage account is an investment account that allows you to buy and sell investments, such as stocks, bonds, mutual funds, ETFs and other assets.

Investors use brokerage accounts to invest for the long term, to save for specific life goals, or for day trading. There are many investment options available through your brokerage. Besides stocks and funds, you may be able to invest in commodities such as gold and silver, or access international investments, option trading or margin trading. This type of account allows you to manage your investments in the way that suits you, whether alone, with a financial advisor or by automation.

When considering which investments to choose in your brokerage account, Nancy Anderson, regional planning specialist at Key Private Bank in Park City, Utah, says retail investors should consider a few things, including the investment term of money and their ability to tolerate risk when markets become volatile.

When incorporating stocks into your portfolio, Anderson says, “stocks offer the best long-term growth over time.” That said, she notes that it’s easier to achieve diversification and, over the long term, better results with a portfolio comprised of mutual funds or ETFs.

Brokerage accounts are taxable accounts, but they can offer some tax flexibility. Typically, investors seek a return on their invested capital by purchasing investments through their broker that will hopefully increase in value in the future, in which case investors can sell at a later date and generate profits.

When you sell securities for a profit, you are then subject to capital gains tax. You will also pay taxes on dividend or interest income. Depending on the type of investments and the length of time they are held, capital gains may be taxed at varying rates. This is more efficient than paying the income tax rate. Compared to a pre-tax IRA, where your investments increase in value, and when it comes time to withdraw money, you’ll have to pay tax on the gains.

Today, many brokerages have no fees for opening an account and offer commission-free investment options. But investors are subject to fees on the investments they buy.

Brokerage accounts allow investors to deposit and withdraw money for a set amount over a set period of time. There are no penalties for withdrawals.

“Accessibility is a double-edged sword since funds can be withdrawn for any reason,” Anderson said.

Anderson notes that since investors must pay taxes on the underlying investments in the account, they should be careful about the investments they purchase in their brokerage accounts.

“The key is to strategize on ways to minimize brokerage account taxes each year by choosing tax-efficient investments, reaping losses versus gains, and targeting the tax treatment of long-term capital gains. tax-efficient,” she explains.

The rise of robo-advisors has made opening a brokerage account easier than ever. Robo Advisors allow you to easily invest and track your investments to see how you are achieving your goals. You can customize your own portfolio or by answering several questions about yourself, the algorithm will tailor an investment plan just for you and manage your investment portfolio regularly.

Brokers provide extensive online tools and resources with which investors can perform in-depth analysis by accessing financial reports, statements, analyst recommendations and more. This gives investors the independence to make sound financial decisions.

Investors don’t necessarily have to choose between a brokerage account or an IRA; you can have both. Each account has its objectives, involves different strategies and gives different results.

“Having both an IRA and a brokerage account allows you to focus on saving for retirement, as well as short-term financial goals like buying a house or a car,” says Mindy Yu, chief investment officer at Stash, a personal finance and investing app.

Either way, Yu says you’re helping make your money work for you — through the potential to earn a return on your investments, while staying ahead of inflation.

“We always recommend investing regularly, thinking long-term, and maintaining a diversified portfolio,” Yu adds, regardless of the type of investment account. “These three tips can help you minimize risk and better position yourself to achieve your unique financial goals.”

According to Anderson, “Since a taxable brokerage account and a tax-deferred retirement IRA account each have their pros and cons, pairing the two can be a perfect solution for investors.”

When focusing on saving for retirement, IRAs may be the better option over brokerages given their tax advantages.

“A taxable brokerage account won’t give you the tax deferral or even the tax advantages that an IRA provides,” says Dunn.

Experts say you might want to open an IRA first, then invest in a taxable brokerage account.

Consider opening a brokerage account when you want to contribute more money than an IRA allows. The more money invested, the more likely it is to accumulate and grow in the long term. Maintaining this practice can translate to more funds to live on while you retire.

While you may be more comfortable having long-term retirement vehicles in an IRA or 401(k), investors who can identify their life goals and have an investment strategy can justify l using both an IRA and a brokerage account – getting the added benefits of both services providing.