When you’re ready to invest, knowing the difference between a traditional IRA and a brokerage account is important. There are many different vehicles you can use for investing. These are two of the most common.
Both a traditional IRA and a brokerage account come with pros and cons. They fit specific situations very well. Let’s look at what both are and how they are different.
What is a Traditional IRA?
A traditional IRA, according to Investopedia.com, is “An individual retirement account, or IRA, is a tax-advantaged investment account designed for retirement savers.” This type of account is used for investing specifically for retirement.
With a traditional IRA, you get to grow your earnings tax-free or in a tax-deferred way. This type of investment account will have strict contribution limits. These limits may change each year, as well. For the 2021 and 2022 tax years, you can contribute up to $6,000 to your IRA or $7,000 if you’re 50 years of age or older.
What is a Brokerage Account?
A brokerage account is a taxable account you can use to buy and sell stocks. With this type of account, you can buy and sell securities without caps on how much you can invest. You can also sell your investments at any time without any type of penalty.
However, brokerage accounts also come with taxes paid on the interest, dividends, and capital gain income. Several brokerage firms are available to help you own a brokerage account. This type of account can be opened and managed right online.
Traditional IRA vs Brokerage Account: The Key Differences
You don’t have to choose between a traditional IRA or a brokerage account. you can have both. However, if you’re trying to figure out which one is best for you, looking at the differences might help.
One of the main reasons you might choose a traditional IRA is the tax benefits. you don’t need to pay taxes on the income from this type of investment every year. Instead, you can deduct your contributions for the year and lower your taxable income.
If you withdraw money from your traditional IRA, you will have to pay income taxes, however. Early withdrawals will also cause a penalty, which you will need to pay. However, if you use the money to pay for a qualified first-time homebuyer expense, you may be able to avoid the penalty.
A brokerage account will be taxed on any interest you earn, dividends you earn, or capital gains. If you make money on this type of account, you will pay tax on it when you file your taxes.
Another key difference between a traditional IRA and a brokerage account is how much you can contribute each year. Traditional IRAs come with limits, while brokerage accounts don’t. Many people will open a traditional IRA and max out the amount they can contribute each year. Then, they will use a brokerage account to add even more investments to their portfolio.
Minimum Deposit to Start
You will also find differences between a traditional IRA and a brokerage account on the minimum starting deposit. Many traditional IRAs require $1,000 to get started. With a brokerage account, you can find some options without any minimum deposit. However, if you want to enable margin trading, you will need to deposit at least $2,000 into a brokerage account.
Traditional IRA vs Brokerage Account: Pros & Cons
There are pros and cons to both a traditional IRA and a brokerage account. You might need one or the other for your situation, but both might be necessary, too.
Traditional IRA Pros
- Comes with tax benefits
- Allows you to defer taxes on the income you’ve earned
- Makes it easy to invest for retirement
- Some combine investment vehicles for a more balanced portfolio
- Some may offer employer contributions
Traditional IRA Cons
- Cannot withdraw money early without a penalty and paying taxes
- Comes with a yearly cap for your contribution
- Doesn’t offer access to all investment vehicles
- Not everybody will qualify for a traditional IRA
Brokerage Account Pros
- No contribution limits
- Some brokerage firms offer very low initial deposits
- Can withdraw your money at any time
- Can trade with margin
- Offers access to options and other investment vehicles
Brokerage Account Cons
- Offers no tax advantages
- Requires more management and decision making
There are pros and cons to both traditional IRAs and brokerage accounts. It’s common to have both of these accounts for your investment strategy.
Do I qualify to contribute to a traditional IRA?
You have to qualify to open a traditional IRA. This means, you must meet specific parameters, but anybody can open and contribute to a traditional IRA. However, if you don’t qualify, you won’t gain the tax deduction each year.
There is an income limit for a full traditional IRA deduction every year. For 2021, if you were single, the limit was an income of $66K. Those filing jointly had a limit of $105K. You won’t be able to gain any type of deduction if you were single and made more than $76K, or married and made $125K or more.
Can I open a traditional IRA through my brokerage firm?
Maybe you want to have a traditional IRA and a brokerage account. It would likely be easier if you had both of these through the same firm, right? You can open a traditional IRA through a bank or a brokerage firm. Typically, a brokerage offers a biter option for your traditional IRA.
Banks have traditional IRAs, but they are rather limited. These IRAs also tend to be low-yield investment options, such as certificates of deposit or savings accounts. You won’t be able to grow your retirement savings substantially with this type of investment vehicle.
With a broker, you can open both your traditional IRA and your brokerage account. This will put both in one place to make it easier to keep track of your money. Of course, you can also choose separate brokers for each.
Choosing between a traditional IRA and a brokerage account isn’t necessary. One may fit better than another for you right now, but you can have both types of accounts.