Roth IRA vs. Brokerage Account: What’s the Difference?

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Long-term financial planning can lead different people to different accounts. Roth IRAs and brokerage accounts both facilitate the same kinds of investments. But to make sure you’re choosing the right one for you, we need to consider:

  • What precisely each account offers
  • The pros and cons of each
  • The similarities and differences
  • The specific tax advantages offered by Roth IRAs

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What is a Roth IRA?

A Roth IRA is one of the seven types of IRAs. It functions as a tax-advantaged savings account with tax benefits that mirror those of traditional IRAs.

When you save in a Roth IRA and follow all the rules, you can withdraw assets tax-free during retirement. The difference between traditional and Roth IRAs is how they’re taxed.

You fund a Roth IRA with after-tax dollars. That means you receive your income, pay income taxes, and do not claim deductions. You then contribute to your Roth IRA, where your assets can grow sheltered from taxes.

Once you reach age 59½, you can start withdrawing from your Roth IRA. If you follow all the rules, you do not need to pay any taxes on the proceeds of your withdrawals.

The rules are similar to those for traditional IRAs. However, with a traditional IRA, you fund your account with pre-tax dollars. You contribute to a traditional IRA and claim a tax deduction for doing so. However, you then have to pay income taxes on the proceeds of your withdrawals, presumably during retirement.

Pros of a Roth IRA

Roth IRAs are the main alternative to traditional IRAs. The differences between the two make them both good options for different people. A Roth IRA could be the right or the wrong choice, depending on your financial circumstances.

In general, Roth IRAs will save you more money than traditional IRAs when you expect to be in a higher income bracket during retirement than you are now. That’s because you’re essentially paying your taxes now, so you don’t have to later. Then, the funds you withdraw during retirement are not taxable. So, if you expect to have other income streams, your Roth IRA withdrawals will not increase your tax burden and raise you into an unfavorable tax bracket. In this way, you can have your cake and eat it too.

Another benefit of Roth IRAs is the increased freedom they offer. For example, you can hold a Roth IRA indefinitely. You also don’t need to worry about minimum investment requirements for maintaining your account. These features further set Roth IRAs apart from popular alternatives.

Cons of a Roth IRA

Of course, if you expect to live off far less money in retirement than you do now, a Roth IRA could be quite counterproductive. In many individuals’ financial circumstances, going with a traditional IRA or a brokerage account will make more sense.

The other issue with Roth IRAs is that, like all IRAs, they have significant limitations. While Roth IRAs are less limited than other IRAs, you still need to consider:

  • The same IRA contribution limits apply ($6,000 in 2021).
  • You must pay taxes now while also contributing, leaving you with less income for immediate needs.
  • There are income limits.
  • You often need to set them up yourself (instead of employer-sponsored retirement plans).

When a Roth IRA Makes Sense

A Roth IRA makes perfect sense when two conditions are met:

  1. You expect to have a higher income during retirement than you do now.
  2. You are saving solely for retirement. 

Even if only one of those conditions is met, a Roth IRA likely makes more sense than a brokerage account.

Another factor worth mentioning is alternative investments. Precious metals and cryptocurrencies are assets that each have their own type of IRA. For example, a crypto Roth IRA enables tax-sheltered growth for your crypto assets. 

Crypto IRA providers like iTrustCapital allow you to purchase cryptocurrencies as a part of your retirement investments. When you open an iTrustCapital Crypto IRA account, you can choose between a traditional, ROTH, or SEP IRA to take advantage of the tax benefits of each account and the low trading fees the platform offers. Visit the iTrustCapital website to learn more about Crypto IRA accounts or open one. 

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What is a Brokerage Account?

A brokerage account is an investment account for trading securities such as:

  • Stocks
  • Bond
  • ETFs
  • Other funds
  • Some alternative investments

An essential distinction between brokerage accounts and IRAs is that brokerage accounts are taxable. They are referred to as “taxable accounts” because you don’t get the tax benefits you do with Roth or other IRAs. 

Investment income you make inside a brokerage account is subject to capital gains taxes. However, capital gains taxes are usually significantly lower than income taxes under current IRS regulations. 

Brokerage accounts are offered by an extensive range of brokerage firms. They range in terms of service, costs, and convenience. There are full-service stockbroker firms, but there are also cheaper online brokers with lower entry requirements and lower costs but less customer service.

Pros of a Brokerage Account

Brokerage accounts are far less restrictive than any kind of IRA. Perhaps the largest difference is that brokerage accounts do not have any contribution limits. You can deposit however much you want into your account. You can then continue to make deposits of any size at any time. You have the complete liberty to invest and/or trade as you please.

Most brokerage accounts also carry no minimum investment balance. Many enable you to create an account without an initial investment at all. There are also no limits to the number of brokerage accounts you open and how much you contribute to each.

Brokerage accounts are simple. They are accounts where an intermediary (your broker) connects you and the assets you wish to acquire/trade. For this reason, there are often no fees apart from small trading margins/fees.

Cons of a Brokerage Account

The cons of brokerage accounts can be summed up by their lack of financial incentives. On the other hand, retirement accounts of all types offer substantial tax incentives for you to use them. They may have restrictions limiting their utility, but their tax sheltering benefits are not matched by brokerage accounts.

Roth IRA vs. Brokerage Account

Brokerage accounts are not meant strictly for retirement savings, but they can be used for that purpose. A Roth IRA, however, offers you tremendous tax advantages intended to give you an edge in retirement savings.

The differences between Roth IRAs and brokerage accounts can be summed up as:

  • Tax savings vs. investment potential
  • Safety vs. liberty

These simplified explanations don’t cover each unique aspect of the two account types, but they offer some point of reference.

Differences Between a Roth IRA vs. Brokerage Account

These are the main differences between a Roth IRA and a brokerage account:

  • No taxes paid on Roth IRA withdrawals; brokerage account profits taxed as capital gains
  • Roth IRA withdrawals before age 59½ penalized; no penalties for brokerage account withdrawals at any time

Similarities Between a Roth IRA vs. Brokerage Account

These are the main similarities between a Roth IRA and a brokerage account:

  • Both enable you to better prepare for long-term financial goals
  • Both facilitate stock, bond, and other investments

Roth IRA vs. Brokerage Account: What Is Right for You?

In general, Roth IRAs are the better option when you are just considering retirement goals. There is little use for Roth IRAs apart from retirement planning. 

Brokerage accounts are more diverse and less restrictive. However, they can be used for many goals, including retirement. If you have more money to invest than your IRA contribution limits allow for, you can use the remainder for brokerage account retirement-oriented investing.

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