brokerage account vs ira

Saving for Retirement: Understanding Brokerage Accounts vs. IRAs

by Josh Swartz

Retirement planning is often a daunting task, even for the financially savvy. Everyone’s retirement needs and goals are different, and with so many options available, it can be challenging to decide which financial products are suitable for your unique situation. 

Individuals who want to start saving for retirement may find themselves overwhelmed when choosing an account type for purchasing and managing investments from the many options out there. While both standard brokerage accounts and traditional and Roth Individual Retirement Accounts (IRAs) offer the ability to launch a solid retirement plan, each type of account has its benefits, restrictions and downsides that you should be aware of. 

Taxable Brokerage Accounts

Taxable brokerage accounts, also known as standard brokerage accounts, are the type of investment account that you are probably most familiar with. After setting up one of these accounts and funding it, you can begin making stock trades and acquiring other types of investment products, including bonds and mutual funds. There are no contribution limits for this type of account: You can fund these accounts at any time with as much money as you choose.

People use brokerage accounts so that they can invest in the stock market, bonds, mutual funds and other financial products. These accounts offer a significant amount of flexibility in that you aren’t required to use funds for specific purposes such as retirement or education: If you want to sell some stock to fund a vacation, pay down an unexpected debt or start a business, you are free to do so. 

Of course, many individuals do include retirement needs in their overall financial plans and will manage their brokerage accounts with these plans in mind. Investors may seek to balance out their portfolios to allow for growth while also protecting assets that may be needed for a retirement nest egg.

Incidentally, these accounts are known as “taxable” brokerage accounts because you’ll be paying both standard income tax on the money you use to fund the account, as well as capital gains tax on any profits made. A capital gain is a profit you make on an investment either by earning dividends or selling an investment product for a price higher than what you paid. These taxes can eat into your earnings, which means that you’ll have to be very conscious of tax issues when making decisions about portfolio management. Professional wealth advisors may be helpful when considering the tax implications of investments.

Individual Retirement Accounts (IRAs)

Individual retirement accounts, better known as IRAs, operate similarly to brokerage accounts: You’ll choose a brokerage firm, open an account, fund the account and begin to invest. The difference, however, is that your tax liability can be significantly less than that of a standard investment account. Depending on the type of IRA you choose, you may be able to deduct the total amount of your annual contributions to your investment account or avoid taxes on withdrawals that you make after you retire. 

Traditional IRAs

With traditional IRAs, deposits into your account are tax-deductible. You won’t have to pay taxes on the portion of your income that you contribute to your IRA. You will, however, have to pay income taxes on withdrawals you take from the account during your retirement.

Roth IRAs

Roth IRAs reverse the tax advantage offered by traditional individual retirement accounts. You’ll continue to pay income taxes on the money you earn and then deposit into your retirement account. However, qualified withdrawals that you make after you retire aren’t subject to income tax.

IRA Limitations

While the tax advantages of IRAs are significant, caution is warranted. In fact, there are multiple issues that can, in some cases, reinforce the importance of having both types of retirement accounts–a standard brokerage account along with an IRA:

  • IRAs are only for people who have earned income, which means that you have earned a wage or a salary from employment or self-employment. If your entire income comes from other investments, an IRA may not be for you. A wealth advisor can help you determine if you have earned income and are eligible.
  • There are strict limits on the amount of money you can deposit into an IRA each year. In 2021, this limit is $6,000 annually, or $7,000 if you are 50 or older. There are even stricter limits for Roth IRAs if your income is above a certain level.
  • There can be financial penalties (including taxes) on making withdrawals from your IRA before you are 59 1/2. If you have a need to access your funds before you are ready to retire, you may want to carefully consider how much of your income you want to deposit into an IRA.

Noting these considerations should not, of course, deter you from taking advantage of all the benefits that an IRA has to offer. But the limitations on annual funding, as well as the restrictions on accessing your funds, should also make it clear that your investment and retirement plan should include different types of accounts, financial products and savings options.

Getting Help with Preparing for Retirement

Retirement planning is complex, particularly since many people live decades after leaving full-time employment and may have significant and unexpected financial needs as they age. Further complicating things is that many people experience changes in income and tax liabilities throughout their careers.

In many cases, having both IRA and brokerage accounts could be an excellent way of obtaining the kind of retirement you want to enjoy. This is because IRAs offer tax benefits while brokerage accounts allow you to invest as much money as you wish into your retirement or other financial goals. A wealth advisor at Gratus Capital can assist in developing a customized investment and retirement plan that meets the needs of you and your family through every life stage.

Sources:

Brokerage Account vs. IRA: What’s the Right Move?

Where to invest first: Roth IRA or a taxable brokerage account