By Sam Taube, NerdWallet
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January is a great time to start working toward your financial goals. If you’re looking to start investing, the first step is to open an investment account. But which kind of account is right for you?
Roth IRAs have tax advantages that make them useful for long-term savings goals such as retirement or, in certain cases, first-time home purchases. Brokerage accounts have fewer rules and more flexibility around when and why you can withdraw profits from them.
Here’s a breakdown of the differences between the two.
There are big differences between Roth IRAs and brokerage accounts in terms of eligibility, investment selection and the tax treatment of earnings withdrawals.
The two account types do share a few features:
Qualified Roth IRA withdrawals are tax-free, as are up to $10,000 in withdrawals for a first-time home purchase at any age. In both cases, the Roth IRA must have been open and funded for at least five years to be eligible for tax-free earnings withdrawals.
You can also open a custodial Roth IRA for a teen to give them a head start on long-term goals. A minor can contribute to a custodial Roth IRA, or you can contribute for them. They just need to have earned income, such as from babysitting or a part-time job, and the total annual contribution cannot exceed their income or the standard limit of $7,000 (whichever is less).
Brokerage accounts don’t enjoy the same tax advantages as Roth IRAs, but they offer much more flexibility on withdrawals. As a result, they may be better-suited for non-retirement goals, such as investing for a big purchase in the next five or ten years.
They may also be useful as a supplemental retirement account, especially for people who are not eligible to contribute to a Roth IRA. Investments in a brokerage account that are held for more than one year are taxed at long-term capital gains rates upon sale — 0%, 15% or 20%, depending on your income at the time of sale. That may be be lower than the ordinary income rates at which traditional IRA distributions are taxed.
Should you use a brokerage account for short-term savings? That’s a complicated question. An oft-repeated adage is that you should not invest money in stocks if you think you’ll need it within five years. In the event of a bear market, this guideline can give your investments time to recover their value.
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Sam Taube writes for NerdWallet. Email: staube@nerdwallet.com.
The article Roth IRA vs. Brokerage Account: What’s the Difference? originally appeared on NerdWallet.
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