Tax-sheltered accounts like the IRA and 401k have long been the go-to replacements for retirement planning. Sure, they’re two solid ways to build up savings for the future, but another way to grow wealth for either the short or long term is to invest in taxable brokerage accounts, such as stocks and mutual funds.
The most notable difference between a 401k or IRA and a taxable brokerage account can be seen when Uncle Sam comes knocking. With taxable brokerage accounts, you pay taxes every year. In contrast, tax-sheltered accounts only involve paying taxes once—when you make your contribution, or when you withdraw your money.
That difference alone is not enough to discount any of these investment options. The smart move is to take a look at the pros and cons of all possible funds in order to make an educated decision.
Related: A guide to self-directed IRAs
What Are Taxable Brokerage Accounts?
Think of taxable brokerage accounts as “traditional” investment accounts—brokerage-offered investment accounts with stocks, bonds and mutual funds.
Taxable brokerage accounts offer:
- No contribution limits
- No withdrawal penalties or limits
- More flexibility with investment options
- More control of taxes since you can determine when you buy or sell investments
Here are details on those offerings.
Brokerage account holders pay taxes each year based on investment income. It’s also important to note that tax liability can vary based on variables like the type of account and an individual’s tax bracket.
One of the best reasons to consider taxable brokerage accounts is the flexibility and control that just aren’t available with a tax-sheltered account. When setting up an IRA, for example, contributions are capped and penalized up to 10% if an account holder withdraws funds too early (or too late). But with a taxable account, account holders can withdraw their money at any time, for any reason, without penalty.
That said, penalty-free doesn’t equal tax-free. Account holders will still have to pay capital gains taxes, but one upside is that the rate can often be lower than regular income-tax rates, particularly if investments have been held longer than a year. Conversely, if the investments decreased in value over the year, it’s possible to take a capital loss, which can offset some of the tax bill.
In addition, where and how much to invest with taxable brokerage accounts is entirely up to the investor. With an IRA or 401(k) one can often choose basic guardrails, such as personal risk level, but the actual funds are managed by a third party. With taxable brokerage accounts, investors can have more control. That’s really the key to success with taxable brokerage accounts—staying on top of investments and making changes when necessary.
For some people, this level of hands-on investing is more of a con than a pro, especially for those who are new to investing, strapped for time or not completely comfortable with money management. It’s for this reason that individual taxable brokerage accounts are often managed by professionals. It’s their full-time job to help you create a smart, hard-working portfolio.
Taxable Brokerage Accounts vs IRA Accounts
Tax-sheltered, or tax-deferred, investment accounts flip the pros and cons of taxable brokerage accounts, and all the restrictions on contributions, withdrawals, and management make them truly designed for long-term investing. Besides having money invested for retirement, the most notable advantages are a more “set it and forget it” investment style, no yearly tax burden and, in some cases, tax-deductible contributions.
Here’s a breakdown of what each tax-deferred account may offer in comparison to a brokerage account.
401(k)s
401(k)savings accounts are one of the most common tax-sheltered accounts. A 401(k) account is an employer-sponsored retirement savings account that both employees and employers can contribute to. Employees can contribute up to $19,500 per year for 2021 and up to $20,500 for 2022, and employees over 50 years old can make additional catch-up contributions of $6,500 annually in 2021 and 2022. Many employers offer 401k plans to employees, some even matching contributions up to a certain percent.
The 401k is one of the easiest ways to grow a retirement nest egg because the contributions are automatic and come out of the employee’s paycheck, so employees may not even notice the money is gone.
Another advantage of a 401(k) is that it can reduce an employee’s taxable income. The funds in the account are not taxed until the employee takes a distribution.
401(k) plans also have some drawbacks. One of the significant disadvantages of a 401(k) account is that if account holders choose to withdraw funds before age 59 ½, they will have to pay a 10% penalty in addition to income taxes. Also, some 401(k) plans may have limited investment options. Since the company selects investment choices that can go into the plan, employees may not have as much control over the account’s investments.
Employees should also be aware of the fees associated with the account. Often 401(k) plans come with administrative fees, investment fees and investment service fees that can chip away at any returns employees may see in their account.
Traditional IRAs
The IRA is a bit more complicated than a 401(k) because, as with taxable brokerage accounts, account holders will need to manage it either independently or with the help of a financial planner.
The traditional IRA has no income limits; as long as someone has a taxable income, they can contribute to a traditional IRA. IRAs are tax-free during contributing years, and contributions are tax-deductible, but account holders are required to start making withdrawals around age 70 ½ that are taxed as income.
As with 401(k) accounts, account holders will have to pay a 10% early withdrawal penalty if they take a distribution before reaching age 59 ½, with a few exceptions.
For investors who think they will be in a lower tax bracket when they retire, a traditional IRA might be a good option. In theory, these investors would save money on taxes by paying them in retirement vs now.
For 2021 and 2022, account holders can contribute up to $6,000 per year (or up to $7,000 if they are over 50 years old).
Roth IRAs
Like brokerage accounts, Roth IRA contributions aren’t tax-deductible. Investors contribute with post-tax dollars, but that also means they won’t be subject to taxes when they withdraw funds in retirement. Contribution limits are the same as traditional 401(k)s, however, there are income limits for who can contribute to Roth accounts. For 2021, income limits start at $125,000 per year for single tax filers and $198,000 for married couples filing jointly. For 2022, income limits start at $129,000 per year for single tax filers and $204,000 for married couples filing jointly.
As with brokerage accounts, Roth IRA account holders can contribute to their accounts at any age. Investors who want to make retirement contributions even after they’ve retired have the option to do so.
Rules around Roth IRA withdrawals are less stringent than those for a traditional IRA. Roth account holders can also begin to take the account’s growth starting at age 59 ½ with no penalty as long as the account has been open for five years.
For those eligible to contribute to a Roth IRA, these accounts make the most sense if the account holder thinks they will be in a higher tax bracket in retirement. Since account holders pay taxes on the contributions in the year they were made, it makes the most sense to pay income taxes when they are in a lower tax bracket.
It’s important to note that some employer-sponsored 401(k) plans give employees the option for a Roth 401(k). With these plans, employer matching contributions are made on a pre-tax basis, while employee contributions are after-tax. For those unsure of their future tax liability, combining the two options might be worth considering, assuming the employer allows.
Which Type of Account Is Best for Me?
With the pros and cons of each type of taxable brokerage accounts vs IRA accounts in mind, here are a few situations that may make sense for each account.
Think About Investing in a 401(k) if…
- Your employer offers a plan with a match program.
- You’re uncertain about your tax liability in the future and your employer allows you to split contributions between a traditional 401(k) option and a Roth 401()k) option.
- You prefer a hands-off approach to investing.
Think About Investing in a Traditional IRA if…
- You want to take advantage of tax-deferred contributions.
- You expect to be in a lower tax bracket in retirement.
- You’ve maxed out your 401(k) contributions and make too much to contribute to a Roth account.
Think About Investing in a Roth IRA if…
- You expect to be in a higher tax bracket in retirement.
- You want the option to pass on the account easily to your heirs.
- You’ve maxed out your traditional 401(k) and want to offset some of your future tax burden with a Roth IRA.
Think About Investing in a Taxable Brokerage Account if…
- You’ve maxed out all contribution limits to your 401(k) and IRAs.
- You want to invest in more tax-efficient investments such as passively managed funds, exchange-traded funds (ETFs) or individual stocks held for more than one year.
- You want more control over your investments with the opportunity to withdraw funds at your leisure.
The Takeaway
Every account—from taxable brokerage accounts to 401(k)s and IRAs—has advantages and disadvantages, which is why some investors choose to invest in a few. The old cliche, “don’t put all your eggs in one basket,” is a solid philosophy for financial planning. Investing in a number of different “baskets” is one way to make sure that your money is working hard for you.
Investors might consider making max contributions to their 401k plan and covering any retirement-income shortages with an IRA. Then, for the shorter term, an efficient mix of taxable brokerage accounts could ensure access to money at any time should the need arise.
Learn more:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA/SIPC. SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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More from MediaFeed:
Guide to Bitcoin IRA: Pros, cons & what to know
A Bitcoin IRA (individual retirement account) is a self-guided retirement account that holds Bitcoin in its portfolio. Typically, most IRAs invest in stocks, bonds, or precious metals. A Bitcoin IRA invests in Bitcoin, and perhaps several different types of cryptocurrency.
There is no official designation for a Bitcoin IRA or Bitcoin Roth IRA by the IRS or any other regulatory agency—the term “Bitcoin IRA” simply refers to an IRA that includes Bitcoin.
Related: How to invest in Bitcoin
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A cryptocurrency IRA could provide some unique benefits, including offering overall portfolio diversification, and potentially unheard of price appreciation.
Grindi / istockphoto
Bitcoin provides a unique way to diversify an individual’s overall investment portfolio.
Given Bitcoin’s extreme outperformance of all other asset classes over the last ten years, it’s often said that Bitcoin is “uncorrelated” with the rest of the investment world. While that trend was upended in early 2020 as Bitcoin experienced a positive correlation with the S&P 500, some investors still consider it a more volatile investment.
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Given the unparalleled price appreciation bitcoin has enjoyed to date, along with the fact that cryptocurrency is an uncorrelated asset class and exists outside the control of any single centralized authority, some investors have wondered if it could be a reasonable retirement option.
There have been periods when Bitcoin traded in tandem with stocks, but from 2009 to 2020, Bitcoin has had over a 1,000,000% price increase (from less than $0.01 to more than $10,000). By comparison, the S&P 500 index provides an average return of 8% annually. That said, past performance is never a guarantee of future returns.
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There are also potential drawbacks to holding investments in a Bitcoin IRA, including both volatility and fees.
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Bitcoin has shown extreme volatility at times. This is one of the main reasons the asset class is considered risky by some, although this perception has begun to change recently.
The list of large corporations (like PayPal, Square and MicroStrategy) and self-made billionaires announcing large investments in bitcoin continues to grow. Successful billionaire investors like Paul Tudor Jones and Stanley Druckenmiller believe that Bitcoin’s overall value proposition outweighs its volatility.
Still, for investors with low risk tolerance, volatility could be a big drawback. Seeing investment funds fall by ten or twenty percent (or more) in a single day can be too much for some people.
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Perhaps the biggest and most assured drawback of investing in a Bitcoin IRA would be the fees involved.
Setting up an account alone could cost thousands. Every trade engaged in on an investor’s behalf could also come with fees in excess of 1% per trade.
And as with other IRAs, withdrawing funds before retirement results in additional fees and taxes.
Taken together, the final taxes and fees could eat into a portion of the profits and tax advantages earned by a Bitcoin IRA.
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The main way to invest in a bitcoin IRA is to use a trusted service provider that helps investors establish IRAs that hold Bitcoin.
There are some companies that have partnered with bitcoin custodial services like BitGo, for example, to help safeguard funds for investors—although these companies cannot guarantee against loss.
The specific process for starting a bitcoin IRA might vary according to which provider an individual chooses.
A Bitcoin IRA provider can help investors buy cryptocurrency to add to their portfolio while also safeguarding the funds for them.
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A cryptocurrency IRA works much like any other IRA. It’s a retirement account that invests in Bitcoin. The main difference for most customers is they will likely be interacting with three different entities:
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These are the companies an individual will deal with when they want to add Bitcoin to their IRA. They are the financial rails through which assets will be converted into Bitcoin.
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These are usually banks, credit unions, or brokerages that hold the assets in an IRA. Traditional IRAs invest in stocks and bonds, but self-directed IRAs allow investors to hold other assets like gold, real estate, or cryptocurrency.
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Typically, a Bitcoin IRA service will have a partnership established with a trusted wallet provider or custody solution that securely holds the private keys to a customer’s Bitcoin funds.
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The answer to this question is “maybe, but probably not.”
401(k) plans generally don’t allow for the direct purchase of cryptocurrency. There are potential ways to roll over a portion of 401(k) funds into Bitcoin, but the easiest way might still be to use a self-directed IRA.
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The answer to this question depends on how a Bitcoin IRA company stores the private keys to an investor’s crypto.
It is widely acknowledged that to be truly safe, keys must be held off-line in cold storage and secured using some kind of multi-signature (multi-sig for short) method. This means that the funds can’t be accessed by any hacker on the internet, and that multiple access methods are required to retrieve any funds.
Multi-sig works kind of like a safety deposit box, where there are two physical keys—one held by the bank and one held by the customer.
Multi-signature security means that there must be at least two means of user verification before funds can be accessed. A basic example would be a customer having to answer emails from two separate email accounts.
More complicated methods might involve some kind of photo or voice identification in addition to multiple emails and an additional key held by the custodian of the funds.
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As far as investment gains or losses are concerned, investors will have to decide for themselves whether or not long-term bitcoin investing is safe in terms of their comfort level and their goals. The technology is only 11 years old at the time of writing.
There’s always a chance, however slim, that the project could fail. That said, the prospect of incredible returns seems to sway more and more investors.
Since 2009, the price of one Bitcoin in US dollar terms has risen well over 1,000,000%, making Bitcoin the best performing asset of the decade—and in history.
While past performance is never a guarantee of future outcomes, if this trend were to continue, it could potentially mean substantial returns for investors over the long term.
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A Bitcoin IRA or Bitcoin Roth IRA is an individual retirement account that holds bitcoin. Instead of a traditional IRA that holds stocks and bonds, a Bitcoin IRA is a self-directed IRA that can hold a variety of assets like gold, real estate, or Bitcoin.
In recent years, several service providers have stepped in to fill the market need for people wanting to add bitcoin to their retirement accounts. While the process is relatively straightforward, one of the major drawbacks that might turn many investors off could be the potential high fees involved.
Learn More:
- Guide to crypto staking: What it is, how it works, and how to get started
- Popular terms every crypto beginner needs to know
This article
originally appeared on SoFi.comand was
syndicated by MediaFeed.org.
SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB . PDF File, have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
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