Brokerage Account vs. IRA

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 is 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.

Why Should You Open a Brokerage Account?

Opening a brokerage account is important for investing and building wealth. It allows you to buy and sell stocks, bonds, and mutual funds. Having a brokerage account gives you access to different investment options that suit your financial goals. It also provides valuable tools like research reports to help you make informed decisions. With a brokerage account, you can explore financial opportunities and manage your future finances proactively.

Diverse Investment Options

Brokerage accounts provide access to diverse investment options. Investors can explore stocks, bonds, mutual funds, ETFs, and options. This variety helps tailor investment strategies to financial goals, risk tolerance, and time horizon. Portfolio diversification is crucial for mitigating risk. Spreading investments across different assets and sectors reduces the impact of market volatility. Different market conditions can be leveraged for returns from various investment vehicles. Global investment options in brokerage accounts allow access to international markets. Diverse investment options help create a balanced portfolio for long-term growth and effective risk management.

Potential for Higher Returns

Opening a brokerage account can lead to higher returns than traditional savings. Investing in stocks, ETFs, or other securities offers access to financial markets with long-term higher returns. Equities can provide capital appreciation and dividends, unlike savings accounts with low interest rates. The stock market historically delivers annualized returns of 7-10%, despite risks. This growth potential helps investors beat inflation and increase wealth effectively. Brokerage accounts offer a variety of investment options like growth stocks and mutual funds to enhance returns. Using a brokerage account enables investors to strategically invest and seize market trends for greater financial gains. Active participation in the market empowers individuals to pursue their financial goals.

Flexibility and Control

Brokerage accounts offer flexibility and control to investors. They can trade stocks, bonds, ETFs, and mutual funds to diversify their portfolios. Investors can decide when to buy or sell based on market conditions. This autonomy allows for personalized investment strategies. Brokerages provide tools like research reports to support decision-making. Active involvement in investments can lead to better financial management.

Considerations Before Opening a Brokerage Account

Understanding the key considerations of opening a brokerage account is important before investing. Choosing the right brokerage is crucial for success and experience. Factors to consider include fees, account types, investment options, customer service, and platform usability. It's essential to align the brokerage with your financial goals, risk tolerance, and investment strategies. Evaluating these factors will help make an informed decision, setting a strong financial foundation.

Fees and Costs

When opening a brokerage account, it's important to understand the fees and costs. Brokers charge fees like trading commissions, account maintenance fees, and expense ratios for mutual funds or ETF. High trading commissions can eat into your gains, especially for frequent traders. Hidden costs like bid-ask spreads and withdrawal fees can also impact your investment. Compare different brokers' fee structures to find the best fit for you. Choosing a brokerage with low fees can increase your returns. Evaluate fees carefully to select the right brokerage for your financial strategy.

Investment Options

Brokers offer access to stocks, bonds, mutual funds, ETFs, commodities, and REITs. A diverse selection helps manage risk and enhance returns. The range of options affects your ability to implement strategies like value investing and diversification. Some investors may have unique interests like socially responsible investing. Ensure the brokerage accommodates your preferences. Understand fees and commissions, as they can impact returns. Reviewing investment options is crucial for aligning your financial goals with the right platform.

Account Features and Tools

Consider the features and tools provided when setting up a brokerage account. These tools can impact your trading efficiency and decision-making. Brokerages provide different tools like advanced charting software and real-time market data. They can help you analyze trends and develop strategies. Other features like automated trading and alerts can make investing easier. User-friendly interfaces and mobile access are important for on-the-go trading. Educational resources can benefit investors of all levels. Consider the costs of these features, as some may have extra charges. Evaluate the features and tools of different brokerages to find one that fits your goals and style. This will improve your investment experience.

What is 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.

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.

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