Brokerage Account vs. IRA: What’s the Difference? (2024)

If you’re new to investing, you might want to compare brokerage accounts and individual retirement accounts (IRA) to decide where to invest. After all, you can invest in stocks and other securities in either account—so what’s the difference?

Broadly speaking, brokerage accounts are taxable accounts that allow you to buy and sell various investments whenever you want—with no contribution limits and no penalties for withdrawals. On the other hand, IRAs are tax-deferred or tax-free accounts (depending on the type of IRA you choose), but there are strict contribution limits, and withdrawals may trigger a penalty.

Here’s a closer look at brokerage accounts and IRAs, with tips to help you decide where to put your hard-earned money.

Key Takeaways

  • Brokerage accounts are taxable investment accounts through which you can buy and sell stocks and other securities.
  • IRAs are designed for retirement savers and allow tax-free or tax-deferred growth on the investments you hold in the account.
  • Unlike brokerage accounts, IRAs have strict contribution limits, and withdrawals may trigger a penalty.
  • Brokerage accounts and IRAs are taxed differently, which can be a deciding factor when choosing an account.

Brokerage Account vs. IRA: An Overview

Brokerage accounts and IRAs are investment accounts that allow you to buy and sell stocks, ETFs, bonds, mutual funds, real estate investment trusts (REITs), and other securities.

Investors generally use brokerage accounts for day trading, long-term investing, and saving for short-term financial goals like buying a house or car. Meanwhile, IRAs offer investors a tax-advantaged way to save for retirement.

It can be a smart financial move to have both types of accounts. That way, you can take advantage of the brokerage account’s flexibility and the IRA’s tax benefits simultaneously. Financial planners often recommend investing in this order:

  1. If you have a 401(k) plan, contribute enough to get the company match first—it’s like getting free money.
  2. Max out your IRAs to take advantage of the tax benefits and the power of compounding.
  3. Invest through your brokerage account.

What Is a Brokerage Account?

As noted, a brokerage account is a taxable account that enables you to buy and sell stocks and other securities. You can buy and sell securities freely, with no caps on the amount you invest—and you can sell your investments anytime without penalty. As far as tax treatment goes, you’ll pay taxes on interest, dividends, and capital gains in the tax year you earn them.

There are dozens of brokerage firms, and choosing the best broker depends on your investing style, preferred investments, and the features you want in a trading platform. Once you decide on a brokerage firm, you can open and fund an account online in minutes.

What Is an IRA?

An IRA is a tax-advantaged investment account designed for retirement savers. The investment choices are limited compared to brokerage accounts (for example, you can’t hold naked options), but contributions and earnings grow tax-free or tax-deferred, depending on whether you have a Roth or traditional IRA.

Unlike brokerage accounts, IRAs have strict contribution limits. You can contribute up to $6,500 ($6,000 for 2022) to your IRA accounts or $7,500 ($7,000 for 2022) if you’re 50 or older.

The limits on IRA contributions change annually to account for cost of living fluctutations.

Roth IRAs (but not traditional IRAs) also have income limits: For 2023, you can only contribute the full amount if your income is less than $138,000 ($129,000 for 2022) for single filers or $218,000 ($204,000 for 2022) if you’re married filing jointly. For 2023, these limits phaseout at incomes between:

  • $138,000 and $153,000 for single filers ($129,000 and $144,000 for 2022)
  • $218,000 and $228,000 for married couples filing jointly ($204,000 and $214,000 for 2022).

In general, withdrawals made before age 59½ can trigger a 10% penalty with either type of IRA, although there are some exceptions to this rule. However, you can withdraw your Roth IRA contributions at any time—for any reason—tax-free and penalty-free.

You can open an IRA with a bank or brokerage firm. Keep in mind that an IRA is not an investment itself—it’s an account that holds the investments you choose. You can pick from various investments, including stocks, bonds, mutual funds, ETFs, REITs, and even real estate (in a self-directed IRA).

How Are Brokerage Accounts and IRAs Taxed?

It's clear that picking profitable investments is vital to investing and growing wealth. However, investing for tax efficiency is equally important since it lets you keep as much of your gains as possible. Depending on your account type, earnings from dividends, interest, and capital gains may or may not be taxable—which brings us to a key difference between brokerage accounts and IRAs.

Brokerage Account Taxes

Brokerage accounts are taxable investment accounts. If you make money because your investments pay interest or dividends or increase in value, you’ll owe tax on that income. The tax liability depends on the source of income:

  • Interest: You might earn interest from investments like bonds, certificates of deposit (CDs), or any uninvested cash you hold in the account. In general, interest income is taxed as ordinary income, with two exceptions: U.S. Treasuries are not subject to state or local income tax, and municipal bonds are usually exempt from federal taxes (and sometimes state and local taxes, too).
  • Dividends: Dividends are your share of a company’s earnings. There are two types of dividends, each with a specific tax treatment. Qualified dividends—which represent most dividends paid to shareholders by public companies—are taxed at the lower, long-term capital gains rate. Unqualified dividends—which usually apply to REITs, master limited partnerships (MLPs), and business development companies (BDCs)—are taxed at the higher ordinary income tax rate.
  • Capital gains: If you sell an investment for a profit, you will owe tax on that gain—but how much tax depends on how long you held the investment. Gains on investments you held for less than a year are considered short-term capital gains and taxed as ordinary income. On the other hand, gains on investments you held for more than a year are taxed at the more favorable, long-term capital gains rate.

IRA Account Taxes

Contributions to a traditional IRA are made with pre-tax dollars and may be tax-deductible, depending on your income and if a retirement plan at work covers you or your spouse. Roth IRA contributions are made with after-tax dollars, so there's no tax break the year you make the contribution. Instead, the tax benefit comes in retirement, when your withdrawals are tax-free.

Earnings in IRAs grow tax-free or tax-deferred, depending on the type of IRA you have:

  • Roth IRA: There’s no upfront tax break, so contributions don’t lower your taxable income. But qualified withdrawals in retirement are tax-free, and you can withdraw your contributions at any time—for any reason—without penalty. And, unlike traditional IRAs, there are no required minimum distributions (RMDs).
  • Traditional IRA: You may be able to deduct traditional IRA contributions the year you make them, which can lower your taxable income (and your tax liability). But withdrawals are subject to income taxes, and early withdrawals usually trigger a 10% penalty. You can avoid the penalty (but not the tax) in certain circ*mstances—like using the money to pay for qualified first-time homebuyer expenses.

Frequently Asked Questions

Should I Open an IRA at a Bank or Brokerage Firm?

Whichever you're comfortable with, but you'll have more investment options—and higher potential earnings—at a brokerage firm. Banks tend to offer minimal, low-yield investment options, such as savings accounts and certificates of deposit (CDs). These low-risk investments may appeal to some retirement savers, but they won’t allow your nest egg to grow substantially—even over the long haul.

Is There a Minimum to Open a Brokerage Account?

That depends on the brokerage firm. Many brokers today offer very low minimum deposits (e.g., even zero) to start. Of course, you will need to deposit at least $2,000 if you want to enable margin trading and $25,000 if you want to day trade.

Is a Roth or Traditional IRA Better?

It depends on your expected income before and after you retire. In general, you’re better off with a traditional IRA if you expect to be in a lower tax bracket when you retire than you are now. If you think you will be in the same tax bracket or higher when you retire, a Roth may be the better choice because you’ll get your tax bill out of the way at your current, lower tax rate.

The Bottom Line

Financial planners recommend having both accounts, if possible. You can use a brokerage account for day trading, long-term investing, and saving for short-term financial goals. In addition, brokerage accounts offer more flexibility than an IRA, and there are no limits on contributions, withdrawals, or income to fund one.

IRAs are intended for retirement savings and have lower annual contribution limits. Withdrawals may trigger a penalty, and if your income is too high, you might not be able to contribute. But the IRA limits and penalties exist to encourage you to keep your money in the account to help you save for retirement. Brokerages—while necessary for trading and certain investing activities—are businesses that exist to make money while helping you access the investments you want.

As an investment expert with a comprehensive understanding of brokerage accounts and individual retirement accounts (IRAs), I bring firsthand expertise to guide you through the nuances of these investment vehicles. My knowledge extends to various financial instruments, tax implications, and strategic investment planning.

Let's delve into the concepts covered in the article:

Brokerage Accounts:

1. Definition:

  • Taxable Investment Accounts: Brokerage accounts are taxable, allowing the buying and selling of various securities without contribution limits or penalties for withdrawals.

2. Characteristics:

  • Flexibility: No caps on investment amounts, and withdrawals can be made anytime without penalties.
  • Tax Treatment: Taxes on interest, dividends, and capital gains are incurred in the tax year they are earned.

3. Selection:

  • Brokerage Firms: There are numerous brokerage firms, and the choice depends on investing style, preferences, and desired platform features.
  • Account Setup: Easily opened and funded online within minutes.

IRAs (Individual Retirement Accounts):

1. Definition:

  • Tax-Advantaged Retirement Accounts: Specifically designed for retirement savers, offering tax-free or tax-deferred growth on investments.

2. Characteristics:

  • Limited Investment Choices: Compared to brokerage accounts, IRAs have restrictions (e.g., limitations on holding naked options).
  • Contribution Limits: Strict annual contribution limits, with variations for age.

3. Types of IRAs:

  • Traditional IRA: Contributions may be tax-deductible, with withdrawals subject to income tax.
  • Roth IRA: Contributions are made with after-tax dollars, offering tax-free qualified withdrawals in retirement.

4. Income Limits:

  • Roth IRA: Restrictions on contributions based on income, with phaseouts at certain income levels.

5. Withdrawals:

  • Penalties: Early withdrawals before age 59½ may trigger a 10% penalty (with exceptions).
  • Roth IRA: Contributions can be withdrawn tax-free and penalty-free at any time.

Tax Implications:

1. Brokerage Account Taxes:

  • Income Sources: Taxation on interest, dividends, and capital gains.
  • Tax Rates: Vary based on the type of income (e.g., qualified vs. unqualified dividends).

2. IRA Account Taxes:

  • Traditional IRA: Contributions may be tax-deductible, withdrawals are subject to income tax.
  • Roth IRA: Contributions are not tax-deductible, but qualified withdrawals are tax-free.

Frequently Asked Questions:

1. Where to Open an IRA:

  • Choice: Between a bank and a brokerage firm.
  • Advantage: Brokerage firms offer more investment options and potentially higher earnings.

2. Minimum Requirements for Brokerage Accounts:

  • Dependence: Varies by brokerage firm, with some offering low or zero minimum deposits.

3. Roth vs. Traditional IRA:

  • Decision: Depends on expected income before and after retirement.
  • Rule of Thumb: Traditional if expecting a lower tax bracket in retirement; Roth if anticipating the same or higher tax bracket.

The Bottom Line:

Financial planners recommend a dual approach, utilizing both brokerage accounts and IRAs. A strategic sequence involves contributing to a 401(k), maximizing IRAs for tax benefits, and then utilizing a brokerage account for additional flexibility. Each account type serves specific purposes, aligning with diverse financial goals and retirement planning strategies.

Brokerage Account vs. IRA: What’s the Difference? (2024)


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