There are so many similarities that it is easy to get them confused. Both a brokerage account and an IRA give you the ability to invest your money into stocks and bonds.
Ultimately, your choice depends on your financial values and preferences. How many choices do you want? Do you prefer to pay taxes on the money you invest or when you withdraw the money?
These questions – and more – all affect which type of investment account is best for you.
What is a brokerage account?
Basically, a brokerage account is an account that allows you to pick and choose which investments to buy and sell stocks and other investments.
As these investments earn interest and dividends, you will pay taxes on this income. You might also have to pay capital gains taxes when you sell stocks, too.
Through a brokerage account, you have the ability to purchase investments such as:
- Mutual Funds
There are a few alluring benefits of a brokerage account.
There is no annual contribution limit with a brokerage account. You can invest as much as you want each year.
A lot of people also like that brokerage accounts do not have fees or penalties for withdrawing money before a certain age.
The biggest drawback is that you don’t get any tax advantages with a brokerage account. In fact, you will have to pay taxes on the financial gain in the year it is received.
What is an IRA?
An IRA is an Investment Retirement Account. Through this account, you are able to purchase unlimited types of stocks and bonds.
You don’t pay taxes on it until you withdraw all your money at the very end. Since it is a retirement account, there are limits on when you can withdraw funds. There are also limits on how much you can contribute.
Types of IRAs
Here is a quick overview of the different types of IRAs:
- Traditional IRA – the most popular kind. Earnings are not taxed until the owner withdraws them.
- Roth IRA – Contributions are taxed, but withdrawals are not taxed. There are annual contribution limits. Withdrawals are tax-free and penalty-free, at any time.
- Simple IRA – This stands for Savings Incentive Match Plan for Employees. It exists for small businesses and self-employed individuals. There are contribution limits and qualifications that a person must meet to open this type of account.
- SEP IRA – This stands for Simplified Employee Pension. This account is set up by employers who also contribute all the funds to it. Employees are not allowed to contribute to it and there are annual contribution limits.
- Nondeductible IRA – This is the type of account someone has if they (or their spouse) have a retirement plan at work and their income exceeds the IRA income limits. They can still contribute to an IRA, but contributions are not tax-deductible anymore.
Depending on the type of account you open, you could receive tax benefits from IRAs that you don’t get from a brokerage account. Either the contributions are not taxed or the withdrawals are not taxed, and you get to choose which one you prefer.
People also like how easy IRAs are to understand and set up. It is usually a quick process and doesn’t have a steep learning curve.
The biggest drawbacks to IRAs depend on the type of account you open. They can be restrictive.
No matter which kind you have, there are contribution limits restricting how much money you can invest in them each year.
For the 2021 and 2022 tax years, you are only allowed to contribute up to $6,000 to your IRA accounts per year if you are younger than 50 or $7,000 per year if you are older than 50.
There are also income limits on IRAs. For example, in 2021, people could only contribute the full amount if their income was less than $198,000 for married filing jointly or $125,000 for single filers.
Another drawback to IRAs is that there is a penalty if you withdraw before you reach retirement age. Most IRAs will charge you a 10% penalty if you withdraw funds before you are 59 ½ years old. The only exception to this is a Roth IRA, which allows you to withdraw money at any time without penalties.
Which is better?
Figuring out which is the better choice depends on your knowledge of stocks, bonds, and securities, your income, and your financial situation.
It’s actually smarter to have both. When you diversify your investments, you have the ability to enjoy the benefits of all of them and will be able to absorb the risks better.
Contact a Financial Advisor
When you are looking at a brokerage account vs IRA, it is important to speak to someone you can trust.
An investment advisor from Advisors Management Group can explain everything in detail and suggest the best options for your financial situation.