Brokerage account vs IRA: which one to invest in?

Saving for retirement is a long game.

While there are many ways to save and invest your hard-earned money, you want to make sure you choose the investment tools that are right for you, including taking into account your current and future tax situation.

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 IRA, or a brokerage account with unique features that can benefit your retirement strategy. overall investment.

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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:

– What is an IRA?

— What is a brokerage account?

– Which one suits you best?

[READ: How to Switch Brokers and Successfully Move Investments.]

What is an IRA?

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

Investing in a traditional IRA allows you to deduct your contributions from your taxes. In return for the immediate tax benefit, you pay tax on your withdrawals when they are made. This means that you will not pay tax on your investment earnings at the current tax rate, but rather at the tax rate at the time the money is withdrawn.

For IRA accounts in 2022, total contributions cannot exceed $6,000. Account holders age 50 or older can contribute up to $7,000.

Besides a traditional IRA, there are several other types of IRAs. A Roth IRA also has a tax advantage, but it’s essentially the reverse of a traditional IRA: the advantage is that you don’t pay tax on your withdrawals, so the money grows tax-free. tax. This allows you to take full advantage of compound growth over time. 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 modified adjusted gross income is less than $129,000 if filing as a single taxpayer or $204,000 for married individuals filing jointly. Brokerage accounts have no restrictions on the amount you deposit.

If you want to withdraw money from your IRA, you may incur withdrawal penalties when the money is withdrawn too soon.

In general, with a traditional IRA, you have to wait until age 59.5 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 rules.

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

You can open an IRA with any starting amount. But the investments you choose for your account, such as mutual funds offered by some brokerage firms, may require a minimum dollar amount.

[SEE: 8 Best Cheap Stocks to Buy Under $10.]

What is a brokerage account?

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, access international investments, trade options, or even trade cryptocurrencies. 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, retail investors need to consider a few things, including how long the money will stay and their ability to tolerate risk when markets turn volatile, says Nancy Anderson , regional planning specialist at Key Private Banking in Park City, Utah.

“Stocks offer the best long-term growth over time,” Anderson said, referring to stocks. 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. Short-term gains, or gains on investments held for less than a year, are taxed as ordinary income. Long-term capital gains, those on investments held for at least one year, are taxed at a lower rate, currently 0%, 15% or 20%, depending on your income.

Today, many brokerages have no fees for opening an account and offer commission-free investment options. But investors are subject to any fees charged on the investments they buy, such as a fund’s expense ratio.

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,” says Anderson.

Anderson notes that since investors have to pay taxes on the underlying investments in the account, they need to be careful about the investments they hold 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 either customize your own portfolio or the algorithm will tailor an investment plan for you and manage your investment portfolio regularly, based on the answers you provide to the questions the robo-advisor asks about your preferences.

Brokers provide extensive online tools and resources with which investors can perform in-depth analysis by accessing financial reports, statements, analyst recommendations and more.

[Investing in ETFs? Here are Our Top Picks for Dividend ETFs. ]

Brokerage account vs IRA

Investors don’t necessarily have to choose between a brokerage account and an IRA; anyone 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, says Yu, you’re helping make your money work for you, through the ability 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 grow in the long term. Maintaining this practice can translate to more funds to live on while you retire.

Take away

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 use both an IRA and a brokerage account – get the benefits of both services.

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Brokerage account vs IRA: which one to invest in? originally appeared on usnews.com

Update 1/25/22: This story was published at an earlier date and has been updated with new information.