When it comes to investing for your future, there are many options to choose from. But which one is the right choice for you? Should you go for a brokerage account or an IRA?
Investing can be a daunting task, especially if you're new to the game. With so many different types of accounts available, it can be difficult to decide which one will provide the best return on investment. Two popular options are brokerage accounts and IRAs.
Choosing between a brokerage account and an IRA can be a tough decision. Both offer unique advantages and disadvantages, and the right choice depends on your individual financial goals and circumstances. In this article, we'll explore the key differences between these two investment accounts to help you make an informed decision.
What's a Brokerage Account?
A brokerage account is an account an investor maintains with a licensed brokerage firm which allows you to buy and sell financial assets such as stocks, bonds, mutual funds, currencies, futures, options, etc.
An investor deposits funds with the brokerage firm to maintain either a cash or margin account. Once a client places an order with the firm, the latter executes it on investors’ behalf in return for compensation, which is called commission.
A broker can be a traditional full-service broker or a discount broker, depending on whether it offers a full range of investment services and is more personalized or acts merely as a platform to route your buy-and-sell orders.
The discount broker typically provides free research and tools as add-ons to its service. Some of the services offered by a full-service broker include financial planning, investing, retirement planning, tax advice and regular portfolio updates.
Consequently, the fee/commission associated with a full service broker is higher compared to the commissions due to the discount broker.
Pros of a Brokerage Account
A brokerage account can offer pros for investors, here are the top pros to consider:
- Brokerage accounts allow some control over when you pay capital gains, as you can decide when to liquidate an investment asset
- There is no restriction on the timing of liquidation or withdrawal of the amount of money in an account
- No penalty is levied on early use of the investments held in the account
- One can earn tax breaks on stocks that have depreciated in value by recognizing a tax loss
Cons of a Brokerage Account
Here are the cons to consider with brokerage accounts:
- Brokerage accounts may have high fees and commissions
- There is a risk of losing money due to market fluctuations
- Brokerage accounts require a certain level of financial knowledge and experience
- The broker may make decisions without consulting the account holder
What's an IRA?
An IRA, or individual retirement account, is a type of savings vehicle specifically earmarked for retirement.. An IRA can be further categorized into a traditional IRA or Roth IRA. The difference between them is the tax treatment associated with each.
A traditional IRA allows tax deductions for contributions toward the account, and the taxes are deferred on the potential investment earnings until the funds are withdrawn.
Deductions for Roth IRA contributions are not allowed, and investment earnings will be distributed tax-free at the time of retirement. You’ll need to opt for a traditional IRA if your income is too high or if you expect to be in a lower tax bracket at the time of retirement.
Pros of an IRA
IRAs come with many pros and are great investment accounts. Here are the pros of an IRA:
- You can defer paying taxes on IRA gains, which allows your finances to grow at a faster rate than a brokerage account
- Traditional IRAs allow individuals to save who are in a higher income tax bracket
- Way to save for retirement, helping individuals to build a nest egg for their future
- An IRA is a better bet when your goal is to build wealth slowly, rather than to generate immediate additional cash flow
Cons of an IRA
It's also important to understand the cons of an IRA. Here are a few disadvantages:
- There is a contribution limit
- Withdrawals before age 59 1/2 may result in penalties
- Required minimum distributions (RMDs) must be taken starting at age 72
- Investment options may be limited compared to other retirement accounts
Types of IRA Accounts
A brokerage account is an investment account maintained just like a savings account you’d have at a bank. However, your money with the brokerage account has the opportunity to grow more quickly, as it is invested in financial assets. Thus, a brokerage account is more growth-oriented. An IRA can also be designated a trust or custodial account for minors. Below you can take a look at the different IRA account options.
A Custodial IRA
This is a type of retirement account that can be set up for your child. Through investing for retirement at an early age, kids have the benefit of compound interest on their side. One way you can do this is to set up a custodial IRA for your child. If your child works and earns money before he or she is an adult, he/she can put some of this money into a custodial IRA.
An IRA Trust
This is an excellent option If you have a lot of money stashed in an IRA. It’s recommended that you set up a revocable living trust, designed to be the beneficiary of your IRA after you die. To back up all the way, IRAs are protected from the claims of creditors while you, the IRA account owner, is living. However, once you die and the IRA assets are given to a beneficiary, the IRA assets lose their protected status.
That’s the reason an IRA Trust should be set up, as it will be protected from creditors, swindlers and lawsuits as long as the funds remain inside the trust.
Restrictions on Investment Amount
The amount earmarked for investment held in a brokerage account has no ceilings or restrictions. Meanwhile, IRAs have restrictions on the investment amount. In 2018, Roth and traditional IRA investors 50 years and under are eligible to contribute up to $5,500 for the tax year, and those over 50 can contribute $6,500, including an additional $1,000 catch-up contribution.
Brokerage Account vs. IRA: Tax Treatment
A regular brokerage account doesn’t offer any tax benefits. The interest and dividends received are usually taxable in the year they accrue. Any earnings on the sales of an investment attracts capital gains tax. On the other hand, when there is a capital loss, a brokerage account permits you receive a tax break.
As discussed earlier, traditional IRA contributions are tax-deductible on tax returns for the year, while withdrawals during retirement are taxed at ordinary income tax rates.
On the contrary, contributions to Roth IRA are not tax deductible but earnings and withdrawals are usually tax-free. Thus, interest, dividends, capital gains and any other income that accrue along the way are free taxation. Also, only the amount that goes into a Roth IRA account is taxed, not the sum that is eventually received.
Brokerage Account vs. IRA: Liquidation Period
It’s mandated that traditional IRA investors withdraw a certain percentage of funds at age 70½, whether you need it or not. Meanwhile, Roth IRAs do not have a mandatory withdrawal amount and contributions can continue to grow tax-free.
Penalty-free qualified distributions can be taken from the age of 59½ for both traditional and Roth IRAs, although to avoid tax payment, a Roth IRA requires the first contribution to be made to the account at least five years before the first withdrawal. The penalty for early withdrawal (before 59½ years) is 10 percent.
Best Online Brokerages
If you would want to invest online but have some guidance, check out one of these online brokers that can get you started.
Finance Your Future
Whether you are putting together your retirement plan, looking for tax advantages, or just want to grow your portfolio, both of these account types can help you reach those goals.
Deciding where you should put your money comes down to assessing your immediate and future financial goals. Depending on how fast you would need your money to grow and your risk tolerance are just a few factors to consider.
Ready to start investing in your future? Benzinga breaks down how to open your IRA account.
Frequently Asked Questions
What are the different types of IRAs?
You can invest in Traditional, Roth, SEP and SIMPLE IRAs.
How many brokerage accounts can I have?
There is no limit to the number of brokerage accounts you can own.
What is the point of a brokerage account?
The main point of a brokerage account is to provide individuals with an easy way to invest in the markets. With a brokerage account, investors can quickly and easily buy and sell investments with the help of an experienced broker or advisor. This allows investors to diversify their holdings and manage their portfolios in accordance with their individual goals, risk tolerance and financial situation.