Brokerage Account vs. Roth IRA: Understanding the Differences

When it comes to deciding how you intend on saving now to pay for your future, retirement plans are a great way to set yourself up for those post-work golden years. While most people are familiar with employer-sponsored 401(k)s and individual retirement accounts (IRAs), alternate options exist that may serve you better. Two such options to consider are the non-tax-advantaged brokerage account and the Roth IRA, each of which has its own set of pros and cons.

Key Takeaways

  • Starting a brokerage account grants you access to the stock market, mutual funds, and other securities.
  • Roth individual retirement accounts (Roth IRAs) allow you to contribute taxable money now so you can have access to tax-free money when you retire.
  • Taxes for either option are handled differently, which may make you prefer one over the other.

How a Brokerage Account Works

If your idea of preparing for the future includes buying and selling a range of investments, then you likely will be interested in a brokerage account. Rather than personally handling the day-to-day trading yourself, you can use a brokerage account (also known as a taxable account) that requires you to deposit your money into an account with a licensed brokerage firm. That firm will then take your funds and use them to make various trades on your behalf. Any assets gained when sold are immediately taxable by the Internal Revenue Service (IRS) as capital gains. You can also manage the assets on your own, without paying the fees for asset management.

Different types of brokerage accounts and brokerage firms can give investors varying degrees of control over their investments. For example, full-service brokers work to provide as much guidance as possible to their clients, albeit at a significantly marked-up rate.

Within each brokerage are different types of accounts as well, such as the cash account and margin account. Cash accounts require that the investor pay for any purchased securities as they’re purchased, while a margin account allows your brokerage firm to lend you cash to buy securities. Existing securities in your portfolio are then used as collateral against the loan that you receive for your portfolio.

Benefits of a Brokerage Account

Just as there are multiple kinds of brokerage accounts, there are numerous reasons why opening one up to plan for the future may be right for you. Here are some reasons why people find brokerage accounts to be an attractive option.

  • No income requirements or contribution limits. Unlike retirement plans, a brokerage account doesn’t discriminate between people with very little income and people with large bank accounts. Nor do brokerage accounts set limits on how much money you can invest in your account.
  • You can invest in nearly anything. One of the most enticing aspects of opening a brokerage account is the flexibility with which you can begin investing. You can build a diverse investment portfolio in which to buy and sell stocks, exchange-traded funds (ETFs), mutual funds, and other securities.
  • You can withdraw funds early without repercussions. Most retirement plans set restrictions on when you can withdraw money from your savings, but nothing is stopping you from withdrawing money out of your brokerage account as long as you pay your taxes.
  • No mandatory distributions. It doesn’t matter how old you are at any given point. You will not be required to take money out of your brokerage account. In fact, if you have any retirement plans with mandatory distributions, you can easily deposit those required withdrawals into your brokerage account.

Drawbacks of a Brokerage Account

While there’s plenty to like about a brokerage account, there are also factors to not consider this decision. The following are some of the reasons why you may not want to open a brokerage account.

  • Returns are not guaranteed. The stock market can be volatile. Whenever you put your money into the market, there is no guaranteed return on your investment.
  • Income and capital gains are taxed directly. Unlike most other retirement investment plans, brokerage accounts are taxed at nearly all levels, including dividends, capital gains, and interest.

How a Roth IRA Works

A Roth IRA is a type of individual retirement account that provides tax-free withdrawals in the future in exchange for making after-tax contributions now. Growth within the IRA is also tax free and can be started as early as you want, as long as you have qualifying earned income.

Benefits of a Roth IRA

Roth IRAs are popular for their flexibility and ease of use. Here are some reasons why you may want to open a Roth IRA.

  • Excellent tax benefits. One of the biggest reasons to use a Roth IRA is the tax benefit that it provides. You don’t pay tax on the earnings on your contributions, and all withdrawals are tax free after you meet some criteria. Your contributions are yours to withdraw at any time.
  • Zero required minimum distributions (RMDs). In some retirement plans, you must begin taking money out of your account at a certain age. Roth IRAs do not have this restriction, allowing you to continue growing your investment after retirement.
  • Potential tax diversification if paired with other retirement plans. Roth IRAs can be combined with other retirement saving plans to diversify how taxes are calculated as money is withdrawn during retirement. Since you’ve already paid taxes on your contributions, any withdrawals from your Roth IRA will not be taxed.

Drawbacks of a Roth IRA

Even though Roth IRAs have many benefits, there are factors to consider before opening one.

  • Taxes are charged as you deposit funds. To get the benefit of zero taxes on future withdrawals, your contributions to the Roth IRA are taxed up front.
  • The maximum contribution level is low. Depending on how much money you make each year, you may be limited on how much you can contribute. In 2022, the limit is $6,000. Those ages 50 and older can contribute an additional $1,000 as a catch-up contribution.
  • Income limits can hamstring contributions. Depending on your modified adjusted gross income (MAGI), you may be limited in how much you can contribute to your Roth IRA. Phaseouts start at $204,000 for a married couple filing jointly in 2022. If you and your partner earn $214,000 per year, you cannot contribute anything.

Important

While you can withdraw contributions from your Roth IRA at any time, you must wait at least five tax years and be at least 59½ years old if you want to do so without incurring taxes or penalties. This is known as the five-year rule.

Are there fees associated with a brokerage account?

You will pay a range of fees if you open and maintain a brokerage account. Those fees include transaction costs like commissions and markups, as well as any extra fees associated with some investments.

How does a discount brokerage work?

Do-it-yourself investors might consider a discount brokerage firm—such as Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity—which carries significantly lower fees than full-service brokerage firms. The price for lower fees tends to be fewer services, though investors who mainly want low-cost investment trades and an easy-to-use online trading software might find this a fair tradeoff.

How does growth work in a Roth individual retirement account (Roth IRA)?

The rate of growth in your Roth individual retirement account (Roth IRA) depends on when you start investing—and what you invest in. If you start early, then you have the benefits of time and compound interest on your side. Even a modest contribution will grow over time if invested in stocks, mutual funds, or exchange-traded funds (ETFs). Starting later will necessitate more up-front investment to reach the same goals.

The Bottom Line

There are plenty of options when it comes to choosing a retirement plan. If your choice is narrowed to opening a brokerage account or starting a Roth IRA, it should come down to where you’re at in life and what you’re able to contribute. With a bit of research and some knowledge about your options, you can find the retirement plan that’s right for you.

Article Sources

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  1. Internal Revenue Service. “Publication 550: Investment Income and Expenses (Including Capital Gains and Losses),” Page 20.

  2. Investor.gov, U.S. Securities and Exchange Commission. “Types of Brokerage Accounts.”

  3. Internal Revenue Service. “Publication 550: Investment Income and Expenses (Including Capital Gains and Losses),” Pages 2–5 and 18–20.

  4. Internal Revenue Service. “Roth IRAs.”

  5. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

  6. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  7. Internal Revenue Service. “Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).”

  8. U.S. Securities and Exchange Commission. “How to Open a Brokerage Account.”

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