A brokerage account vs. an IRA: Everything you need to know

How do you decide between investing in a brokerage account vs IRA?

If you are new to investing, you might want to know whether you should invest in a brokerage account vs IRA account. It is important for you to understand the differences between a brokerage account vs IRA account when you are trying to make the choice. In some cases, it might make sense for you to have both types of accounts.

The brokerage definition is a firm that buys and sells securities and assets for their clients. A brokerage account is an account that does not offer tax benefits. When the investments in your account earn interest or dividends, the taxes that accrue will be taxed during that tax year. If you sell investments from your account, you may also face capital gains taxes.

An IRA is an individual retirement account. Traditional IRAs are tax deferred accounts that allow your earnings to grow without taxes over time. When you contribute to a traditional IRA, you might be eligible to claim tax deductions. You will be taxed at the time that you begin making withdrawals.

While a brokerage financial account is a taxable account, there are still some reasons why you might want to consider opening a taxable brokerage account. This type of account might offer you more flexibility in your investment choices. A brokerage account compared to an IRA has differences with when you can choose to liquidate your investments and pay capital gains taxes, and there are differences between a brokerage account vs IRA in terms of contribution limits and withdrawal rules.

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According to a report by Deloitte that was commissioned by the U.S. Department of Labor, approximately 17 million households have accounts at brokerages. An additional 3 million households only have IRAs. The number of households with brokerage accounts fell from 19 million over an 11-year period while the number of households that only had an IRA increased by 1 million.

An estimated 9.5 million households held both brokerage and IRA accounts. Brokerage accounts are more common among higher-income households. Among households in the top 10 percent, half have these types of accounts. By comparison, only 2.8 percent in the bottom 25 percent reported that they have brokerage accounts.

Why should you compare a brokerage account to an IRA in financial planning?

When you are engaged in financial planning, it is important for you to compare a brokerage account to an IRA. If you want to invest in the stock market, it is important for you to have a brokerage account. These are taxable accounts that you open at a brokerage firm. After opening your account, you can then place buy and sell orders for stocks. Brokers then fulfill the orders for the investor and might charge fees in exchange for doing so.

Financial planning takes into account all of your financial goals. An IRA is important for long-term retirement goals while a brokerage account is good for short-term growth and long-term wealth-building. While you can enjoy tax-deferred growth in an IRA or tax-free growth in a Roth IRA, a brokerage account lets you contribute unlimited amounts of money and to declare capital losses when you sell securities. When you compare a brokerage account to an IRA, you might determine that opening both types of accounts might offer you the greatest benefits.

Types of brokerage and IRA accounts

There are several different types of brokerage and IRA accounts. A brokerage account to IRA comparison should incorporate the different types of accounts so that you can make the choices that can benefit you the most.

Types of IRAs

An IRA can help you to save money for retirement. Everyone should have some type of long-term savings account for retirement so that they can live comfortably during their golden years. There are multiple types of retirement accounts, including the following:

  • Traditional IRA
  • Roth IRA
  • 401(k)
  • SEP IRA
  • SIMPLE IRA

Each of these types of IRA accounts offers different benefits, contribution limits, and withdrawal rules. Three of the IRAs, including 401(k) accounts, SEP IRAs, and SIMPLE IRAs, are retirement accounts that you can get through your employer or open for yourself if you are self-employed. Traditional IRAs and Roth IRAs are individual retirement accounts that you can open on your own. We will explore the differences between these IRAs below.

Types of brokerage accounts

There are three types of brokerage accounts, including cash, margin, and options accounts. A cash account is an account in which you pay for the securities that you choose in full at the time of purchase.

A margin account is a type of financial account in which you must eventually pay for the securities that you purchase in full. However, your broker extends a loan to you to purchase securities at the time of your purchase, and the securities in your account will serve as collateral for the loan.

An options account is a type of account in which you can invest in options. An option is a type of derivative that might be sold through a broker. An options contract gives an investor the right to purchase or sell an underlying asset at an agreed price by a specific date. The date is referred to as the strike date.

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How IRAs and brokerage accounts are set up

To set up an IRA account, you can take the following steps:

  • Choose the type of IRA account that you want such as a traditional IRA or a Roth IRA;
  • Pick the financial institution that will serve as a trustee of your account;
  • Pick the type of fund or customize your portfolio;
  • Choose your investments; and
  • Open your account and fund it.

A brokerage account compared to an IRA can be set up as follows:

  • Decide what type of account you need
  • Compare the costs
  • Look at the services that are offered
  • Pick your brokerage firm
  • Complete the application
  • Fund your account
  • Research and choose your investments

Contributions and limits

A brokerage account to IRA comparison includes a review of the contributions and limits. Different types of IRAs have different contribution rules. Here is an overview of the contributions and limits that apply to different types of accounts.

IRAs

IRAs have contribution limits that differ depending on the type. If you have a traditional or Roth IRA and are under age 50, you can contribute a maximum of $6,000 per year. If you are over age 50, you can contribute another $1,000 per year as a catch-up contribution for a total of $7,000.

SEP IRAs and SIMPLE IRAs are types of accounts that are designed for employers. If you are self-employed and have a SEP IRA, you can contribute a maximum of 25 percent of your income or $56,000, whichever is less. However, if you have eligible employees, you must also contribute the same percentage to their accounts.

SIMPLE IRAS are another type of employer-sponsored IRA. The maximum contributions for people under age 50 are $13,000. For those over 50, the catch-up contribution amount is $3,000 per year for a total of $16,000. Finally, 401(k) accounts have an annual contribution limit of $19,000 for people under age 50. There is a catch-up contribution of $6,000 per year for people who are over age 50 for a total of $25,000.

Brokerage accounts

Brokerage accounts do not have any contribution limits. This means that you are able to make unlimited contributions to these taxable accounts.

Tax benefits

Different tax rules apply to a brokerage account compared to an IRA. A brokerage account is taxable. However, if you hold your investment securities for longer than a year in your account, you can pay the lower long-term capital gains rate of 15 percent.

Roth IRA contributions are made on an after-tax basis. Your contributions can grow tax-free, and you will not pay taxes when you begin making withdrawals. However, there are income limits for contributing to a Roth IRA.

Contributions that are made to traditional IRAs, 401k accounts, SIMPLE IRAs, and SEP IRAs are made on a pre-tax basis. This allows your savings to grow on a tax-deferred basis. You may be able to claim tax deductions during the years in which you make contributions. However, you will be taxed at your ordinary income tax rate at the time that you begin making withdrawals.

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Withdrawals, distributions, and penalties

When you compare a brokerage account to an IRA, there are different rules regarding withdrawals, distributions, and penalties as follows:

  • Traditional, SEP, SIMPLE, and 401ks- Early withdrawal penalties of 10 percent if younger than age 59 1/2
  • Roth IRAs- Early withdrawal penalties of 10 percent, but some withdrawals are exempt
  • Brokerage- Can withdraw money at any time without paying a penalty

If you have a traditional, SEP, or SIMPLE IRA, you will have to start taking mandatory minimum distributions after you reach age 70 1/2. Roths and brokerages do not have required minimum distributions, and you can continue making contributions to these two types of accounts for as long as you want.

Advantages and disadvantages of a brokerage account

A brokerage account has several advantages and disadvantages. The advantages include the following:

  • Invest without income limits
  • No contribution limits
  • Unlimited investment choices
  • Penalty-free withdrawals at any time
  • No required minimum distributions

The disadvantages of a brokerage account compared to an IRA include the following:

  • Earnings are taxable in the year that they are realized
  • Must pay capital gains tax when you sell investments

Advantages and disadvantages of an IRA

The advantages of an IRA include the following:

  • Tax-deferred growth for traditional, SEP, SIMPLE, and 401k accounts
  • Tax-free growth for Roth IRAs
  • Contributions to traditional IRAs may be deductible 
  • Roth IRAs allow you to make withdrawals after you retire tax-free
  • No RMDs for Roth IRAs

The disadvantages of IRAs include the following:

  • Contribution limits
  • RMDs for all IRAs except for Roths
  • Early withdrawal penalties
  • Income limits for Roth IRAs
  • Limited investment choices

Transfers from brokerage accounts and IRA rollovers

When you compare a brokerage account to an IRA, there are different processes involved with transferring a brokerage account vs IRA rollovers. The process for transferring an account from one brokerage firm to another is largely automated. However, it is important for it to be handled correctly to avoid problems. To initiate the transfer process, customers must do the following:

  • Choose the new brokerage firm
  • Request that the new firm provide a transfer initiation form (TIF)
  • Complete the TIF and give it to the current brokerage

The delivering and receiving firms have certain responsibilities under the law. The delivering firm must review the customer data that is provided to it. If anything does not match the firm’s records, the transfer will be denied. The delivering firm must send a list of assets to the receiving firm once it has validated the transfer.

The receiving firm will review the list of assets and determine whether it wants to accept the transfer. A transfer might be rejected if the quality of the securities is poor. Once everything is validated or approved, the delivery process takes three days.

IRA rollovers occur when you roll over the money held in one IRA account into another one. The IRA process is generally straightforward and includes the following steps:

  • Contact the plan administrator of the plan from which you will be rolling over your funds;
  • Tell the plan administrator to send the funds directly to the trustee at your new IRA plan; or
  • Withdraw the funds and deposit them in the new plan within 60 days.

The M1 Finance investment platform

M1 Finance is a brokerage and investment platform that utilizes cutting-edge digital technology combined with expert investment knowledge and advice. When you open an account with M1 Finance, you can choose the type of account that will best suit your needs.

You can set up automatic funds transfers so that you can invest without having to think about it. M1 Finance allows investors to choose their own investments and to weight them according to the percentages that each one will have. M1 Finance completes automatic rebalancing so that your investments are optimized and that you can enjoy optimal growth.

The benefits of M1 Finance

M1 Finance allows you to invest without fees or commissions. This allows your money to grow faster. Investors can build their own personalized portfolios or select a portfolio that has been created by experts that matches their risk tolerance levels. Investors are also able to borrow money from their accounts through loans at low rates. Start investing now.

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