In a Roth IRA I can purchase up to $6500 dollars of funds per year. What would the difference be if I had a brokerage account and purchased the same funds? With a brokerage account I wouldn't have the $6500 limit that an IRA has. Is there a big difference between the two other than one being strictly for retirement?
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1Good answers below, while you're learning about retirement savings you should research investment order as well, I know I've written a couple answers that mention priority order like this: money.stackexchange.com/a/131160/52448 But there are plenty of search results that will discuss the reasoning and considerations that might affect your decisions.– Hart COCommented Aug 22, 2023 at 23:27
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@dave_thompson_085: You completely missed the point John is making. If you have a balance of $30,000 in a Roth IRA (which took multiple years to contribute), you can trade all $30,000 into a new fund.– Ben VoigtCommented Aug 23, 2023 at 15:19
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Aren't "Roth IRA" and "brokerage" orthogonal concepts? Pretty sure there are Roth IRA brokerage accounts where you can buy stocks, as well as non-Roth non-brokerage accounts like cash savings.– NayukiCommented Aug 24, 2023 at 0:45
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1@BenVoigt: That's the first two sentences and I agree with them. The third sentence is "For a Roth IRA you can deposit as much as you want" and that's wrong. (I mentioned some cases where it can be more than $6,500, but there is no case where it is unlimited.)– dave_thompson_085Commented Aug 24, 2023 at 3:00
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I meant Standard, not Roth. I fixed it.– JohnFx ♦Commented Aug 24, 2023 at 15:09
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3 Answers
What would the difference be if I had a brokerage account and purchased the same funds?
A Roth IRA grows tax free. When you take money out of the IRA (not necessarily when you sell the investments within it), if you meet the conditions for a qualified withdrawal, then you are not taxed on the earnings that are withdrawn. Your contributions can always be withdrawn without tax since they were "taxed" before you put them in.
Since there's no tax until you withdraw, you don't have to worry about tracking dividends or capital gains distributions. It's all lumped into "earnings" when you withdraw.
In a non-retirement brokerage account, any dividends, other distributions, and capital gains when you sell investments, are subject to applicable taxes in the year in which they occur.
You didn't ask, but a "Traditional" IRA is tax deferred. You get a tax deduction (subject to eligibility rules) when you contribute, and are not taxed on earnings until you withdraw, but the entire withdrawal is treated as "income", not just the growth.
Traditional IRAs do not get preferential tax treatment for long-term capital gains or qualified dividends. All "income" is taxed at your marginal rate. So it's typically preferred to invest in securities that have high expected growth rather than paying dividends.
answered Aug 22, 2023 at 20:53
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1I don't follow the last sentence (“Neither type of IRA...”). Do you think you could give an example? Commented Aug 23, 2023 at 6:30
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1@adam.baker In a regular brokerage account, capital gains are taxed at a lower rate than earned income and dividends. When you withdraw from an IRA, the tax (if any) is all at the rate of earned income. So there's not much reason to prefer investments that produce capital gains rather than dividends.– BarmarCommented Aug 23, 2023 at 13:43
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1@adam.baker If I have $1,000 of long-term capital gains in a non-retirement account (meaning I sell a stock that I've had for over 1 year and have $1,000 profit), then I owe between 0 and 20% tax depending on my tax bracket (15% being the most common bracket). If I instead sell it within a Traditional IRA and withdraw the profit, it's treated as ordinary income and taxed at 10-37% tax (with 22-24% being the most common) Commented Aug 23, 2023 at 13:50
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Earnings within Roth IRAs aren't taxed, and qualified distributions are completely tax-free. Contrast that with a standard brokerage/investment account, where capital gains, interest, dividends, etc. are all taxable when they're earned/realized.
Do note that you must make a qualified distribution to fully enjoy the tax benefits of a Roth IRA.
A qualified distribution from a Roth IRA (one that avoids taxes on earnings and the additional 10% penalty) is a distribution made 1) more than 5 years after the first contribution AND 2) the owner is at least 59.5 years old OR is disabled OR the distribution qualifies for the first home exception ($10,000 lifetime limit).
If the distribution is non-qualified, there are taxes on the earnings and the 10% penalty might apply unless you meet various exceptions.
Additionally, there's a Roth IRA distribution order that is always followed, which can help if you need to make a non-qualified withdrawal:
- Original contributions (never taxed or subject to penalty)
- Conversions on a first-in-first-out basis, with taxable conversions for the earliest year removed first (never taxed but may be subject to penalty), then non-taxable conversions for the same year (never taxed or subject to penalty), then moving to the next earliest year and repeating.
- Earnings on contributions (maybe subject to tax and penalty).
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1"then taxable conversions, then non-taxable conversions" I believe conversions are ordered by year, and then within each year taxable before non-taxable Commented Aug 22, 2023 at 22:07
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Just to add to the other answers, possibly unnecessarily: There's no reason you can't have both a tax-protected retirement account (IRA, 401k, or equivalents) that you fund as heavily as you feel comfortable with or up to the limit, and straight investments (for money beyond those limits, and/or which you might need to access before then but probably not in the next year or so). And CDs and bank accounts and so on, of course, depending on the time frame you're looking at.
