When you focus on saving for retirement, IRAs may be the better option than brokerage firms, considering their tax advantages. A taxable brokerage account won't provide you with tax deferral or even the tax advantages offered by an IRA, Dunn says. When comparing a traditional IRA to a brokerage account, the biggest incentive to open an IRA instead of a brokerage account is to have tax advantages. The two main types of IRAs are traditional and Roth, and the main difference between them is the type of tax advantage.
Traditional IRAs and brokerage accounts are two types of investment vehicles. While IRAs help investors save for retirement in a tax-efficient way, brokerage accounts tend to offer more flexibility because they are not subject to the same rules that affect IRAs. Which one is best for you depends on your needs, goals and time horizon. A financial advisor can help you choose between the two and determine the best way to invest your money to meet your financial goals.
While there's no doubt that there are some good reasons to use a taxable brokerage account, especially when it comes to retirement flexibility, the money you have in a traditional IRA versus dozens of brokerage firms, and choosing the best broker depends on your investment style, your preferred investments, and the features you want to have on a trading platform. In addition, if you prefer to invest in more sophisticated securities, such as derivatives, you can do so with a brokerage account. This means that capital gains, interest income, or dividends generated by investments within an IRA are not immediately taxed. Because brokerage accounts are not subject to RMDs, money can remain invested in the account for a lifetime, making them potentially valuable components of an estate plan.
If you make money because your investments pay interest or dividends or increase in value, you'll owe taxes on that income. 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 can carry a penalty. In general, saving for retirement with an IRA, 401 (k) plan, or other employer-sponsored plan should take precedence over investing in a brokerage account. If you don't qualify to participate in an employer's plan, your ability to contribute to an IRA is only restricted if your spouse has an employer-sponsored retirement plan.
Investing rental income is considered passive and contributions to traditional IRAs and Roth must come from active income or workers' compensation. In general, you do better with a traditional IRA if you expect to be in a lower tax bracket when you retire than you are now. Author, professor, investment expert with almost two decades of experience as an investment portfolio manager and financial director of a real estate holding company. For example, if you own a mutual income fund that invests in dividend stocks, you won't have an annual tax liability associated with those dividends.
As a retirement account, a Roth IRA has certain tax advantages that aren't available in a regular investment account. Investments grow without capital gains taxes or dividends, and all qualified Roth IRA withdrawals are 100% tax-free, regardless of the tax bracket you are in at the time of withdrawal.