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Brokerage Account vs. Roth IRA


Brokerage accounts and individual retirement accounts (IRAs) offer two very different ways to invest. A Roth IRA, for example, can offer the advantage of tax-free distributions in retirement while a brokerage account doesn’t cap annual contributions. You might choose to open one account or both, depending on your needs. Understanding the differences between a brokerage account vs. Roth IRA can help you decide where they fit into your investment strategy. Use SmartAsset’s free matching tool to find a financial advisor who can help you build a retirement plan.

What Is a Brokerage Account?

A brokerage account is an investment account that allows you to buy and sell different securities. That can include stocks, bonds, mutual funds and exchange-traded funds. Some brokerage accounts also make it possible to buy and sell cryptocurrency, futures and options or invest in initial public offerings (IPOs).

Brokerage accounts can also be referred to as taxable accounts since any profits realized from the sale of securities are subject to capital gains tax. These accounts can be offered online through discount brokerages or through a full-service broker.

Aside from allowing you to trade securities, brokerage accounts can come with added features. For example, you may have access to a sweep account or cash management account (CMA). A sweep account transfers uninvested cash to a high-interest investment option. Cash management accounts can be used to hold funds you plan to invest but they can earn interest and offer check-writing or debit card access.

What Is a Roth IRA?

Brokerage Account vs. Roth IRA

A Roth IRA is a tax-advantaged retirement account that allows you to contribute money each year, then withdraw that money tax-free when you retire. Roth IRAs are funded with after-tax dollars and your ability to contribute to one of these accounts is based on income and filing status. Here are the Roth IRA income limits for 2022:

  • $129,000 to $144,000 for single taxpayers and heads of household
  • $204,000 to $214,000 for married couples who file a joint return
  • $0 to $10,000 for married couples who file separately

This means that if you’re single, you can make the full contribution to a Roth IRA if your income is under $129,000 for the year. If your income exceeds that amount, you can make a reduced contribution. Once your income passes $144,000, your ability to contribute to a Roth IRA phases out completely. The same applies to the other filing statuses.

In terms of how much you can contribute to a Roth IRA, the IRS establishes the annual contribution limits. These limits are receive adjustments periodically for inflation. Here’s what you can contribute to a Roth IRA for 2022:

  • $6,000 if you’re under age 50
  • $7,000 if you’re age 50 or older

The higher contribution limit for those 50 and older includes a $1,000 catch-up contribution. These contributions can help help older savers “catch up” to their savings goals by investing more in their IRAs as they get closer to retirement.

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

There are three main differences between brokerage accounts and Roth IRAs:

  • Who can open one
  • How much you can contribute
  • Tax treatment

Anyone can set up a brokerage account to start trading, regardless of how much you earn or your tax filing status. With a Roth IRA, you have to observe the income limits for your filing status to determine how much, if anything, you might be able to contribute.

Brokerage accounts don’t limit how much you can invest each year. So if you want to put $1,000 in your brokerage account to trade each month, you can without having to worry about breaking any IRS rules. A Roth IRA, on the other hand, doesn’t allow for unlimited contributions. And if you make excess contributions to one of these accounts, you’ll have to take that money back out to avoid a tax penalty.

In terms of tax treatment, brokerage accounts are subject to capital gains tax. This tax applies when you sell an asset for more than what you paid for it. Capital gains tax is due the year you realize the gain. So if you sell 100 shares of XYZ stock for a $10,000 profit in 2022, then you’d owe capital gains tax on that amount when you file your 2022 tax return.

There are two capital gains tax rates: Short-term and long-term. The short-term capital gains tax rate applies to investments that you hold for less than one year. So if you buy shares of stock, then sell them six months later for a profit you’d be taxed at the short-term rate, which is the same as your ordinary income tax rate.

The long-term capital gains tax rate, on the other hand, maxes out at 20%. This rate kicks in for capital gains when selling investments that you’ve held for longer than one year.

Neither a brokerage account nor a Roth IRA offers a tax deduction for contributions. But a Roth IRA can offer something that’s potentially even better in the form of tax-free distributions starting at age 59.5. When you make qualified distributions from a Roth IRA, they’re tax-free. And you can withdraw your contributions at any time, without a tax penalty.

Brokerage Account vs. Roth IRA: Which Is Best for You?

Brokerage Account vs. Roth IRA

A brokerage account isn’t necessarily better than a Roth IRA, as they can both be useful when investing for retirement. You may, however, have access to a wider range of investments with a brokerage account vs. a Roth IRA. With an IRA, you might be limited you to mutual funds, index funds or exchange-traded funds (ETFs) only.

If you’re looking to diversify your portfolio while enjoying tax-free growth, then you might decide to open one of each. You could use your brokerage account to invest money for the short- or long-term, being mindful of what you might pay in capital gains tax. Meanwhile, you could fully fund your Roth IRA each year to create tax-free income when you’re ready to retire.

Also, keep in mind that you can contribute to either type of account even if you’re already saving in a 401(k) at work. Investing in a brokerage account or Roth IRA won’t affect your contributions to your 401(k) and doing so can help you develop multiple streams of income for retirement.

Bottom Line

Whether it makes sense to open a brokerage account vs. Roth IRA can depend on how much you need to save to reach your retirement goal and what type of tax benefits you’d like to enjoy. When opening either type of account, it’s important to consider what you might pay. With brokerage accounts, it’s good to look for a commission-free option as this can save you money on fees when making trades. And with a Roth IRA, it’s important to consider the expense ratios for each fund you plan to invest in.

Retirement Planning Tips

  • Consider talking to a financial advisor about whether to open a brokerage account vs. Roth IRA. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Let’s say you’re not eligible to contribute to a Roth IRA based on your income and filing status. You can still save for retirement on a tax-advantaged basis using a traditional IRA. A traditional IRA doesn’t have any income restrictions and you may be able to deduct 100% of your annual contributions. The contribution limits for traditional IRAs are the same as Roth IRAs. They also include the additional $1,000 catch-up contribution for savers aged 50 and older.

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