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

It's More Than Just Tax Advantages

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Investors have many options available when it comes to where to put their money. But certain accounts are designed for retirement investing and therefore come with certain tax advantages. A Roth individual retirement account (IRA) and a brokerage account are two of the most popular tools for inventors, but they have very different features, rules, and benefits.

Are you wondering whether a Roth IRA or taxable brokerage account is right for you? Learn more of the differences between the two accounts, how to choose one or the other, and how to use both accounts to get the best of both worlds.

What’s the Difference Between a Roth IRA and a Brokerage Account?

  Roth IRA Brokerage Account
Taxation Tax-advantaged Taxable
Contribution Limits $6,000 No contribution limits
Eligibility Subject to eligibility requirements No eligibility requirements
Withdrawals Subject to early-withdrawal penalties Withdrawals allowed at any time

Taxation

One of the most important differences between a Roth IRA and a brokerage account comes down to the taxation. As a retirement account, a Roth IRA has certain tax advantages that aren’t available in your run-of-the-mill investment account.

When you contribute to a Roth IRA, you contribute with after-tax dollars. However, once the funds are in the account, they grow tax-free over time. When you withdraw the funds during retirement, you won’t pay taxes on them. The only tax liability attached to a Roth IRA is the income taxes you paid on the money you earned before you contributed it to your Roth IRA.

When you’re investing in a taxable brokerage account, you’ll have to pay taxes on your earnings. Here are a few different types of taxes one might be subject to:

  • Dividends: When companies pay dividends to their investors, those dividends are a form of income. The rate that dividends are taxed at depends on whether they are ordinary or qualified dividends. Ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at capital gains rates.
  • Capital gains: When you sell an investment for a profit in a taxable brokerage account, you will pay capital gains taxes. A short-term capital gain is when you sell an investment after holding it for one year or less, while a long-term capital gain occurs when you sell after holding your investment for more than one year. Long-term capital gains have a more favorable tax treatment.
  • Interest: If you earned interest from a savings account, certificate of deposit, bonds, or other similar investment, the IRS taxes that interest as income at your ordinary income tax rate.

Contribution Limits

Roth IRAs come with some serious tax advantages, which is why the IRS places limits on how much you’re able to contribute. In 2022, you can contribute up to $6,000 to your Roth IRA. If you’re age 50 or older, you can make a catch-up contribution of an additional $1,000, for a total contribution limit of $7,000. Keep in mind that these limits are for traditional and Roth IRAs combined. You can contribute to both accounts in a year, but only up to a combined $6,000.

The good news with taxable brokerage accounts is that there are no contribution limits. While a taxable brokerage account doesn’t come with the tax advantage a Roth IRA offers, it doesn’t have the advantage of letting you contribute as much as you want each year.

Eligibility

Another key difference between a Roth IRA and a taxable brokerage account is who is allowed to contribute. Because of their tax advantages, there are limits in place as to who can contribute to a Roth IRA. The chart below shows how much you can contribute to a Roth IRA based on your income and filing status (as of tax year 2022).

Filing Status Income Contributions
Married filing jointly or qualifying widower Up to $203,999 Up to $6,000 (or $7,000 if age 50 or older)
Married filing jointly or qualifying widower $204,000 to $213,999 Reduced amount
Married filing jointly or qualifying widower $214,000 or more No contributions allowed
Married filing separately Up to $9,999 Reduced amount
Married filing separately $10,000 or more No contributions allowed
Single, head of household, or married and both filing and living separately Up to $128,999 Up to $6,000 (or $7,000 if age 50 or older)
Single, head of household, or married and both filing and living separately $129,000 to $143,999 Reduced amount
Single, head of household, or married and both filing and living separately $144,000 or more No contributions allowed

However, there is an exception to these Roth IRA income limits. Using a tool called a Roth conversion, you can convert funds in a traditional IRA into Roth contributions. Keep in mind that if you’ve already claimed a deduction for your traditional IRA contributions, you’ll have to pay income taxes on the funds you convert. Also, you’ll have to pay taxes on money that generated returns.

When it comes to opening a taxable brokerage account, you don’t face the same age, income, and filing-status requirements as you do with a Roth IRA account. When you sign up for the account, you’ll just have to provide personal information such as your telephone number, address, government identification, and annual income.

Withdrawals

The final key difference between a Roth IRA and a taxable brokerage account is the withdrawal rules. You can withdraw your Roth IRA funds tax-free during retirement, but to do so, you’ll have to meet certain requirements.

If you withdraw funds in any situation other than those allowed by the IRS, you’ll pay a 10% early-withdrawal penalty on those funds.

Roth IRA withdrawals must be made in the following circumstances to avoid penalties:

  • You’re age 59½ or older and you’ve reached a five-year holding period since first contributing to the account, OR
  • You meet one of the allowable exceptions, such as using the withdrawal to make a first-time home purchase (up to $10,000), pay for college, pay for birth or adoption expenses (up to $5,000), pay for unreimbursed medical expenses, or you become disabled, OR
  • You’re withdrawing substantially equal payments.

The one exception to the Roth IRA early-withdrawal penalties is when you’re withdrawing your Roth IRA contributions but not your earnings—basically, up to the total you’ve already contributed but not more than that. Because you’ve already paid taxes on those dollars, you can withdraw them tax-free and penalty-free before age 59½.

Which Is Right for You?

When you’re choosing between a Roth IRA and a taxable brokerage account, it’s important to consider what you’d like to use the money for.

A Roth IRA is designed to help you save for retirement, which is why it has the tax advantages, contribution limits, and withdrawal requirements that it does. If you’re looking for an account to park your investments until retirement, a Roth IRA could be a great option.

When you’re saving for retirement, a Roth IRA isn’t your only option. Other tax-advantaged accounts, such as a traditional IRA or 401(k) plan, are available, and each offers its own unique tax benefits.

While a Roth IRA is well-suited to saving for retirement, a taxable brokerage account is a great option for saving for other short- and long-term goals. These accounts have more flexibility, meaning you can withdraw your money exactly when you need it rather than abiding by IRS withdrawal restrictions. And due to the lack of contribution limits on these accounts, you can save more aggressively for your goals.

A ‘Best of Both Worlds’ Option

If you’re confused trying to choose between a Roth IRA and a brokerage account, there is good news: You don’t necessarily have to choose. Instead, you can build a portfolio that includes both a tax-advantaged account such as a Roth IRA and a taxable brokerage account.

Roth IRA and brokerage accounts are ideal for different investing situations. One investor can use both tools simultaneously to invest for retirement in a Roth IRA while saving for other short- and long-term financial goals in a brokerage account.

The Bottom Line

A Roth IRA and a brokerage account are two of the most popular investment tools available to help you grow wealth and save for your goals. They have some key differences, including their tax treatment, contribution limits, eligibility requirements, and withdrawal rules.

Remember, you don’t have to choose between a Roth IRA and a brokerage account. You can use both accounts simultaneously to save for different types of financial goals.

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