General Investing vs Roth IRA: Understanding the Difference

General Investing vs Roth IRA: An Overview

Whether you're planning to save in a Roth IRA or intend to invest through a brokerage account, it's important to understand the difference.

Benefits of a Roth IRA

A Roth IRA offers several advantages for retirement savers. First, contributions to a Roth IRA are made with after-tax dollars, meaning you've already paid taxes on the money you contribute. This allows your investments to grow tax-free, and when you withdraw the funds in retirement, you won't owe any taxes on the earnings. Additionally, a Roth IRA offers more flexibility when it comes to withdrawals. You can withdraw your contributions at any time without penalty, and if you meet certain criteria, you can also withdraw your earnings tax-free before age 59 ½.

Drawbacks of a Roth IRA

While a Roth IRA offers many benefits, there are some drawbacks to consider. One major drawback is the income limitations for contributing to a Roth IRA. In 2021, single filers with a modified adjusted gross income (MAGI) above $140,000 and joint filers with a MAGI above $208,000 are not eligible to contribute to a Roth IRA. Additionally, contributions to a Roth IRA are subject to annual limits. In 2021, the maximum contribution is $6,000 for those under age 50 and $7,000 for those age 50 and older. Lastly, while Roth IRA withdrawals are generally tax-free, there are exceptions. If you withdraw earnings before age 59 ½ and don't meet one of the qualifying criteria, you may owe taxes and penalties on the earnings.

Benefits of a Brokerage Account

A brokerage account offers more flexibility and options for investing compared to a Roth IRA. With a brokerage account, you can invest in a wide range of assets, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). You can also actively manage your investments and make trades as needed. Additionally, there are no income limitations or contribution limits for a brokerage account, allowing you to invest as much as you want.

Drawbacks of a Brokerage Account

While a brokerage account offers more flexibility, there are also some drawbacks to consider. First, investments in a brokerage account are subject to capital gains taxes. When you sell an investment that has increased in value, you'll owe taxes on the capital gains. Additionally, a brokerage account does not offer any tax advantages like a Roth IRA. You won't be able to enjoy tax-free growth or tax-free withdrawals in retirement.

Key Differences: Taxes

One of the key differences between a Roth IRA and a brokerage account is how they are taxed. With a Roth IRA, contributions are made with after-tax dollars, meaning you've already paid taxes on the money you contribute. The investments within the Roth IRA grow tax-free, and qualified withdrawals in retirement are also tax-free. On the other hand, a brokerage account does not offer any tax advantages. You'll owe taxes on any dividends, interest, or capital gains earned within the account. When you sell an investment for a profit, you'll owe capital gains taxes on the earnings.

Should I Open an IRA at a Bank or Brokerage Firm?

When it comes to opening an IRA, you have the option to do so at a bank or a brokerage firm. Both options have their pros and cons. Opening an IRA at a bank may offer more stability and a wider range of fixed-income options, such as certificates of deposit (CDs) and Treasury bonds. However, the investment options may be limited compared to a brokerage firm. On the other hand, opening an IRA at a brokerage firm gives you access to a wider range of investment options, including stocks, bonds, and mutual funds. However, there may be more risk involved, as the value of your investments can fluctuate.

Is There a Minimum to Open a Brokerage Account?

Many brokerage firms have minimum requirements to open an account. The minimum amount can vary depending on the firm, but it's typically around $1,000 or higher. Some firms may waive the minimum requirement if you set up automatic monthly contributions or if you're transferring a certain amount of assets from another account.

Is a Roth or Traditional IRA Better?

Deciding between a Roth IRA and a traditional IRA depends on your personal financial situation and goals. A Roth IRA may be a better option if you expect to be in a higher tax bracket in retirement or if you want the flexibility to withdraw your contributions at any time without penalty. On the other hand, a traditional IRA may be a better option if you want to take advantage of the tax deduction for contributions now and expect to be in a lower tax bracket in retirement.

The Bottom Line

General investing and a Roth IRA have their own advantages and drawbacks. A Roth IRA offers tax-free growth and tax-free withdrawals in retirement, but contributions are subject to income limitations and annual contribution limits. A brokerage account offers more flexibility and investment options, but investments are subject to capital gains taxes. Ultimately, the best option for you depends on your personal financial situation and goals. It may be beneficial to consult with a financial advisor to determine the best approach for your individual needs.