Brokerage Account vs. IRA: Which Should You Invest In?

Saving for retirement is a long-haul kind of game.

While there are many ways to save and invest your hard-earned money, you want to make sure you’re picking the investment tools that are right for you, including considering your current and future tax situation.

You may be in a situation where you’ve 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 may benefit your overall investing strategy.

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Each account has different purposes. Broadly 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 are what can ultimately sell an investor, given that money is subject to taxation at some point. Here’s what you need to know about IRAs and brokerage accounts that may help you efficiently invest for the long term:

— What is an IRA?

— What is a brokerage account?

— Which one is best for you?

[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 advantage, you pay taxes on your withdrawals when they are made. This means you won’t pay taxes on your investment returns at the current tax rate, but rather at the tax rate at the point at which the money is withdrawn

For IRA accounts in 2022, the total contributions cannot be more than $6,000. Account holders who are 50 or older can make contributions up to $7,000.

Apart from a traditional IRA, there are several other types of IRAs. A Roth IRA also carries a tax advantage, but it is essentially the reverse of a traditional IRA: The benefit is that you don’t pay taxes on your withdrawals, so the money grows tax-free. This allows you to take full advantage of compounding 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 those who are self-employed. This is different than a Savings Incentive Match Plan for Employees, or SIMPLE IRA plan, which gives employees and employers the chance 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 you file as a single taxpayer or $204,000 for married people filing jointly. Brokerage accounts have no restrictions on how much money you contribute.

If you wish to withdraw money from your IRA, you may incur withdrawal penalties when the money is taken out too early.

In general, with a traditional IRA, you have to wait until the age of 59½ to withdraw money without a penalty; otherwise, you will incur a 10% penalty along with federal and state charges. At age 59½, you can start to withdraw money from your IRA with no penalties but are subject to taxes that may be due.

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

“You can usually invest in the same securities in your IRA that you can in a taxable brokerage,” says Nikki Dunn, a certified financial planner based in Houston. Dunn explains this gives people a wide array of investment options while taking advantage of tax rules.

Choose investments that fit your investor profile, risk tolerance, time horizon and overall investing goals. By contributing to your IRA on a consistent cadence — either monthly, quarterly or annually — this tax-advantaged retirement account will likely appreciate over time.

You can open an IRA with any starting amount. But the investments you choose for your account, like mutual funds offered by particular brokerages, 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 for long-term investing, saving up for particular life goals or day trading. There are many investment options through your brokerage. Apart from stocks and funds, you may be able to invest in commodities such as gold and silver, access international investments, options trades or even trade cryptocurrencies. This type of account allows you to manage investments in a way that’s suitable for you, whether it’s on your own, with a financial advisor or through automation.

When thinking about what investments to choose in your brokerage account, retail investors need to consider a few things, including how long the money will be invested and their ability to tolerate risk when the markets get volatile, says Nancy Anderson, regional planning specialist at Key Private Bank in Park City, Utah.

“Equities provide the best long-term growth over time,” Anderson said, referring to stocks. That said, she notes that it’s easier to get diversification and, over the long term, better results from a portfolio composed of mutual funds or ETFs.

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

When you sell securities at a profit, you are then charged capital gains tax. You will also pay taxes on dividends or interest income. Depending on the type of investments and the length of time they are held, capital gains can 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 a year, are taxed at a lower rate, currently 0%, 15% or 20%, depending on your income.

Today, many brokerages do not have fees for opening an account and offer commission-free investment options. But investors are subject to any fees charged on investments they purchase, such as a fund’s expense ratio.

Brokerage accounts allow investors to deposit and withdraw money at any given amount in any given period. There are no penalties for withdrawals.

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

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

“The key is strategizing on ways to minimize the taxes in the brokerage account each year by choosing tax-favored investments, harvesting losses against gains and aiming for the tax-favored, long-term capital gains tax treatment,” 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’re reaching your goals. You can either customize your own portfolio, or the algorithm will tailor an investment plan for you and will manage your investment portfolio regularly, based on answers you provide to questions the robo advisor asks about your preferences.

Brokerages provide full-scale online tools and resources with which investors can do thorough 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 purposes, involves different strategies and yields different results.

“Having both an IRA and brokerage account allows you to focus on saving for retirement, along with shorter-term financial goals like buying a house or a car,” says Mindy Yu, director of investments at Stash, a personal finance and investing app.

In both cases, Yu says, you’re helping to put your money to work for you — via the potential of earning a return on your investments, as well as 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 you to hit your unique financial goals.” According to Anderson, “Since a taxable brokerage account and an IRA tax-deferred retirement account each has their benefits and drawbacks, pairing the two can be a perfect solution for investors.”

When your focus is saving for retirement, IRAs may be the better option over brokerages, considering their tax advantages.

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

Experts say you may want to start by opening an IRA and 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 greater the opportunities for it to grow over the long run. Keeping up with this practice can result in more funds to live off of as you ease into retirement.

Takeaway

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 investing strategy can justify using both an IRA and a brokerage account — getting the benefits both services provide.

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Brokerage Account vs. IRA: Which Should You Invest In? originally appeared on usnews.com

Update 01/25/22: This story was published at an earlier date and has been updated with new information.

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