You Could Lose Thousands by Opening the Wrong Kind of Brokerage Account
by Christy Bieber | Published on Sept. 19, 2021
Choosing the right brokerage account could make all the difference in your final balance.
When you open a brokerage account, you have to select what kind of account you want. While this may not seem like a decision with a huge impact, making the wrong choice could cost you thousands of dollars each year.
Some brokerage accounts come with hefty tax breaks
The main reason you could lose money with your brokerage account is that some come with tax breaks, and others don't.
If you are saving money for retirement, you may want to open a traditional or a Roth IRA instead of a standard taxable brokerage account. Here's how they work:
- Traditional IRAs allow tax-deductible contributions. In retirement, you are taxed on withdrawals at your ordinary income tax rate.
- Roth IRAs are contributed to with after-tax dollars. You do not pay taxes on withdrawals when you retire.
These accounts do come with some restrictions that taxable brokerage accounts don't. For example:
- With a traditional IRA, you aren't allowed to take out contributions or gains you've earned on your investment until you reach the age of 59 ½. If you take money out earlier, you owe a 10% early withdrawal penalty, unless you fall into a limited hardship exemption.
- This same penalty applies to gains in a Roth IRA , although you can withdraw contributions without penalty at any time (just not gains).
The upfront tax savings and the fact your money can grow tax-free still make an IRA well worth investing in -- especially since you shouldn't take your retirement money out early. Doing so can compromise your future financial security.
Just how much could you lose by picking the wrong brokerage account?
The tax breaks from IRA investing are valuable, and the losses you incur by not taking advantage of them can really add up. In 2021, for example, you can make up to a $6,000 deductible contribution to a traditional IRA, provided your income doesn't exceed certain limits. If you're over 50, you can contribute an additional $1,000, for $7,000 total.
You aren't taxed on this money, since it's deducted from your taxable income. The amount you save as a result depends on your tax bracket. If you max out your $6,000 contribution and are in the 22% tax bracket, contributing to a traditional IRA could save you $1,320 in taxes. And that's just in one year. You save every year you invest in an IRA.
The savings in a Roth IRA come later, and can be harder to calculate since it depends on your tax rates as a retiree. But if your tax rate is higher later in life, this account could provide the most tax savings.
Regardless of what kind of IRA you choose, the bottom line is that government help is available, and there's little reason not to get a tax break to make investing for your retirement easier. So if you are going to save for your later years, consider choosing an IRA as your account type. And if you decide an IRA works for your needs, check out the best brokers for IRAs to find a brokerage that offers the features you need to save for your future.
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