Brokerage Account vs IRA: What’s the Difference?

By Jonathan K. Perry Last updated Apr 19, 2022

If you are new to investing, you may want to compare brokerage accounts to 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?

Generally speaking, brokerage accounts are taxable accounts that allow you to buy and sell various investments whenever you want, with no contribution limits or penalties for withdrawals. On the flip side, IRAs are tax-deferred or non-taxable accounts (depending on what type of IRA you choose), but there are strict contribution limits and withdrawals can result in a penalty. Here’s a more in-depth look at brokerage accounts and IRAs, with tips to help you decide where to put your hard-earned money.

Key points to remember

Brokerage accounts are taxable investment accounts through which you can buy and sell stocks and other securities.
IRAs are designed for retirement savings and allow tax-free or tax-deferred growth on the investments you hold in the account.
Unlike brokerage accounts, IRAs have strict contribution limits, and withdrawals can result in a penalty.
Brokerage accounts and IRAs are taxed differently, which can be a deciding factor when choosing an account.

Brokerage Account vs IRA: An Overview

Brokerage accounts and IRAs are investment accounts that allow you to buy and sell stocks, ETFs, bonds, mutual funds, real estate investment trusts (REITs) and other securities. .

Generally, investors use brokerage accounts for day trading, long-term investments, and to save for short-term financial goals, such as buying a house or a car. Meanwhile, IRAs offer investors a tax-efficient way to save for retirement.

Having both types of accounts can be a smart financial decision. This way, you can simultaneously enjoy the flexibility of the brokerage account and the tax advantages of the IRA. Financial planners often recommend investing in this order:

If you have a 401 (k) plan, contribute enough to get the business first, it’s like getting free money.
Maximize your IRAs to take advantage of tax benefits and the power of compounding.
Invest through your brokerage account.

What is a brokerage account?

As noted, a brokerage account is a taxable account that allows you to buy and sell stocks and other securities. You can buy and sell securities freely, with no cap on the amount you invest, and you can sell your investments at any time without penalty. In terms of tax treatment, you’ll pay taxes on interest, dividend, and capital gains income in the tax year you earn it.

There are dozens of brokerage firms out there, and choosing the best broker for you depends on your investing style, preferred investments, and what features you want in a trading platform. Once you’ve chosen a brokerage firm, you can open and fund an account online, usually within minutes.

What is an IRA?

An Individual Retirement Account, or IRA, is a tax-advantaged investment account designed for retirement savings. Investment choices are limited compared to brokerage accounts (for example, you can’t hold bare options), but income grows tax-free or tax-deferred, depending on whether you have a Roth or a Traditional IRA.

Unlike brokerage accounts, IRAs have strict contribution limits. For the 2021 and 2022 tax years, you can contribute up to $ 6,000 to your IRA accounts, or $ 7,000 if you are 50 or older.

Roth IRAs (but not traditional IRAs) also have income limits: for 2021, you can only contribute the full amount if your income is less than $ 125,000 for single filers or $ 198,000 if you’re married. and file jointly. These limits increase for the 2022 tax year when the elimination begins at $ 129,000 for single filers and $ 204,000 for married couples filing jointly.

In general, withdrawals made before the age of 59.5 can trigger a 10% penalty with either type of IRA, although there are some exceptions to this rule. However, you can withdraw your Roth IRA contributions at any time, for any reason, tax-free and without penalty.

You can open an IRA with a bank or brokerage firm. Keep in mind that an IRA is not an investment in itself, it is an account that holds the investments you choose. You can choose from a variety of investments, including stocks, bonds, mutual funds, ETFs, REITs, and even real estate.

How are brokerage accounts and IRAs taxed?

No one would say that choosing profitable investments is an essential part of investing and growing wealth. However, investing in a tax-efficient way is just as important, because it allows you to keep your earnings as much as possible. Depending on the type of account you have, dividend, interest, and capital gains income may or may not be taxable, which brings us to a key difference between brokerage accounts and IRAs.

Taxes on brokerage accounts

Brokerage accounts are taxable investment accounts. If you earn money because your investments earn interest or dividends, or because your investments increase in value, you will owe tax on that income. Tax liability depends on the source of income:

The interest. You can earn interest on investments such as bonds, certificates of deposit (CDs) or on uninvested cash you hold in the account. In general, interest income is taxed like ordinary income, with two exceptions: U.S. Treasuries are not subject to state or local income tax, and municipal bonds are generally exempt from tax. ‘federal taxes (and sometimes state and local taxes as well).
Dividends. Dividends are your share of a company’s profits. There are two types of dividends and each has a specific tax treatment. Eligible dividends, which represent most of the dividends paid to shareholders by public companies, are taxed at the lower long-term capital gains rate. Unqualified dividends, which generally apply to REITs, Master Limited Partnerships (MLPs) and Business Development Corporations (BDCs), are taxed at the highest regular tax rate.
Capital gains. If you sell an investment for a profit, you will owe tax on that gain, but the amount of tax depends on how long you have held the investment. Gains on investments you have held for less than a year are considered short-term capital gains and taxed as ordinary income. In contrast, gains on investments that you have held for more than a year are taxed at the more favorable long-term capital gains rate.

Taxes on IRA accounts

Contributions to a traditional IRA are made with pre-tax dollars and may be tax deductible, depending on your income and whether you or your spouse is covered by a workplace pension plan. Roth IRA contributions are made in after-tax dollars, so there is no tax relief in the year you make the contribution. Instead, the tax benefit comes in retirement, when your withdrawals are tax-free.

Income from IRAs increases tax-free or tax-deferred, depending on the type of IRA you have:

Roth IRA. There is no initial tax relief, so contributions do not reduce your taxable income. But withdrawals eligible for retirement are tax-free, and you can withdraw your contributions at any time, for any reason, without penalty. And, unlike traditional IRAs, there are no minimum required distributions (RMDs) for Roth IRAs.
Traditional IRA. You may be able to deduct traditional IRA contributions in the year you make them, which can reduce your taxable income (and your tax liability). But withdrawals are subject to income tax, and early withdrawals usually carry a 10% penalty. You can avoid the penalty (but not the tax) in certain circumstances, such as using the money to pay for a first-time buyer’s qualifying expenses.

Should I open an IRA at a bank or brokerage firm?

While you can open an IRA at a bank or brokerage firm, you will have more investment options and higher potential income with the latter. Banks tend to offer very limited, low return investment options, such as savings accounts and certificates of deposit (CDs). These low-risk investments may appeal to some retirement savers, but they won’t allow your nest egg to grow substantially, even over the long term. You will usually find a much wider selection of investments and greater growth potential if you open an IRA on a brokerage account.

Is there a minimum to open a brokerage account?

It depends on the brokerage firm. Many brokers today offer very low minimum deposits (eg, even zero) to start with. Of course, you will need to deposit at least $ 2,000 if you want to enable margin trading.

Is a Roth or a Traditional IRA Better?

With a Roth IRA, contributions are not tax deductible, but withdrawals eligible for retirement are tax-exempt (even for income). Traditional IRA contributions are tax deductible, so you could save money at tax time for the year you contribute. But you will owe income tax on withdrawals at retirement, including all that growth. In general, you’re better off with a Traditional IRA if you expect to be in a lower tax bracket when you retire than you are today. If you think you will be in the same or higher tax bracket when you retire, a Roth may be the best choice because you will get your tax bill at your current and lower tax rate.

The bottom line

Financial planners recommend having both accounts, if possible. You can use a brokerage account for day trading, long-term investing, and for saving for short-term financial goals, while an IRA is 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 incur a penalty, and if your income is too high, you may not be able to contribute.