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When you open a brokerage account, you need to select the type of account you want. While it might not seem like a huge impact decision, making the wrong choice could cost you thousands of dollars every year.
Here’s why.
Some brokerage accounts come with significant tax breaks
The main reason you could lose money with your brokerage account is that some come with tax breaks and some don’t.
If you are saving money for retirement, you may want to open a traditional IRA or a Roth IRA instead of a standard taxable brokerage account. Here is how they work:
- Traditional ARIs allow tax deductible contributions. At retirement, you are taxed on withdrawals at your regular tax rate.
- Roth IRA are assessed with after-tax dollars. You don’t pay withdrawal tax when you retire.
These accounts have certain restrictions that taxable brokerage accounts do not have. For example:
- With a traditional IRA, you are not allowed to withdraw any contributions or gains you have earned on your investment until you are 59½ years old. If you withdraw money 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 no winnings).
The upfront tax savings and the fact that your money can grow tax free make an IRA always worth investing, especially since you shouldn’t be withdrawing your retirement money. early. This can jeopardize your future financial security.
How much could you lose by choosing the wrong brokerage account?
The IRA investing tax breaks 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 $ 6,000 in deductible contributions to a traditional IRA, as long as your income does not exceed certain limits. If you are over 50, you can contribute an additional $ 1,000, for a total of $ 7,000.
You are not taxed on this money, since it is deducted from your taxable income. The amount you save this way depends on your tax bracket. If you max out your contribution by $ 6,000 and are in the 22% tax bracket, contributing to a traditional IRA could save you $ 1,320 in taxes. And it’s just in a year. You save all year you invest in an IRA.
The savings in a Roth IRA come later and can be more difficult to calculate because they depend on your tax rate as a retiree. But if your tax rate is higher later in life, this account could save you the most tax.
Whichever type of IRA you choose, the bottom line is that government help is available, and there is little reason not to get tax relief to make it easier to invest for your retirement. So, if you are planning to save for your later years, consider choosing an IRA as your type of account. And if you decide that an IRA meets your needs, check out the best brokers for IRAs to find a broker that offers the features you need to save for your future.
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