Should You Open a Brokerage Account if You Haven't Maxed Out Your Retirement Plan?

by Maurie Backman | Published on Oct. 19, 2021

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Not sure when to start investing in a brokerage account? Here's what to know.

You often hear that saving for retirement is important. Social Security will only replace about 40% of the average earner's wages, which means most seniors need more than just those benefits to live comfortably. And that's where personal retirement savings come in.

If you have a 401(k) plan through work, it pays to sign up and have money deducted from your paychecks to go into that account. If you don't have access to a 401(k), you can open an IRA and save for retirement there.

It's a good idea to try to max out your retirement plan -- meaning, contribute enough to hit the maximum allowable contribution for the year. That number changes from year to year. Right now, it's $6,000 for an IRA and $19,500 for a 401(k) if you're under 50. If you're 50 or older, these limits rise to $7,000 and $26,000, respectively.

Clearly, maxing out a 401(k) is a pretty tall order. And maxing out an IRA can be challenging if you earn a lower income or have many bills to grapple with. But still, it's a good goal.

But what about investing in a brokerage account? As important as it is to fund your retirement plan, shouldn't you put some money into a brokerage account as well?

It's all about balance

Some financial experts say it pays to first max out a retirement plan, and then put any leftover money into a brokerage account. The reason? Both IRAs and 401(k)s offer a host of tax breaks. Traditional IRAs and 401(k)s allow your money to go in tax free. If you put $6,000 into an IRA this year, that's $6,000 of income the IRS won't tax you on now.

Your money grows, tax-deferred, until you take withdrawals in retirement. That means you won't be taxed on investment gains in your account year after year. Rather, you'll pay taxes on those gains and on your withdrawals when you remove funds from your IRA or 401(k) during retirement.

Roth IRAs and Roth 401(k)s, meanwhile, don't give you an immediate tax break on your contributions. But your investments in a Roth account grow completely tax free, and withdrawals are tax free in retirement.

Regular brokerage accounts don't offer these tax benefits. If you put $1,000 into a brokerage account, there's no tax break on that money. Any gains you take in your brokerage account are taxed for the year you earn them. If you sell stocks in a brokerage account for a $500 gain this year, you'll owe the IRS taxes on that gain when you file your 2022 return.

It's easy to see why savers are often advised to max out a retirement plan before funding a brokerage account. But that may not be the route you want to take.

While brokerage accounts don't offer tax breaks, they do come with one big benefit -- unrestricted access to your money. If you need to cash out investments in a pinch, you can do so without penalty. With an IRA or 401(k), you'll risk facing a 10% penalty if you withdraw money before the age of 59 and 1/2 (there are some exceptions to this rule but you shouldn't necessarily bank on qualifying for one). And so a brokerage account gives you more freedom for taking money out when you want or need to.

Also know that while you can invest in individual stocks with an IRA, 401(k)s generally limit you to different kinds of funds (like mutual funds and index funds). If you keep your retirement savings in a 401(k) but want to own individual stocks, you may want a brokerage account for that reason alone.

It pays to have both types of account

Once you've maxed out a retirement account, opening a brokerage account becomes a bit of a no-brainer. But even if your IRA or 401(k) isn't maxed out, it still makes sense to put some cash into a brokerage account. You may want to put more of your money into a retirement account for the tax breaks, but a brokerage account could complement that IRA or 401(k) nicely.

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