Diving into the world of investing can be quite confusing, even if you have some past experience and sound intuition. Investors have countless choices in terms of strategy and account types. You may wonder about the distinction between an IRA and a brokerage account. Like the Bobbsey sisters from high school, they have key similarities but also some major differences.
An IRA is an individual retirement account. Although the IRS permits penalty-free use of IRA funds for a few other purposes, Congress' main goal when creating the IRA was to give investors a tax-efficient way to save for retirement. View your IRA primarily as a way to fund your golden years so you don't have to collect soda cans and rely on the relative pittance of Social Security. You can hold your IRA in a brokerage account. A brokerage account gives you the ability to invest in any number of products, including stocks, mutual funds, exchange-traded funds, options, commodities and currencies. Simply put, you can hold your IRA in a brokerage account, but you can also hold it solely in the funds of a mutual fund family or in investments sponsored by your bank, such as certificates of deposit. Owning an IRA in a brokerage account, however, gives you access to all of the above-mentioned investments and more.
Firms generally ask the same questions when you open an IRA as they do when you open a brokerage account. You must provide basic contact information; verification data, usually by submitting your driver's license number; your Social Security number for both verification and tax purposes; and a funding method. In both cases, you select whether you want to open an individual, joint, custodial or trust account. When you open a brokerage account, firms give you the option of opening it as an IRA. With an IRA, you'll generally have the option of selecting an account beneficiary or beneficiaries. For both, you can usually conduct the entire process online at a bank's, mutual fund company's or brokerage's website.
If you open a straight brokerage account -- one that you do not designate as an IRA -- you have more frequent tax reporting duties. As you accumulate earnings -- capital gains, dividend payments, interest -- in your brokerage account, your brokerage keeps track of them. At the end of the year, it sends you IRS forms detailing these earnings. You must report them and pay applicable taxes to Uncle Sam. With an IRA, the rules change. Your account grows on a tax-deferred basis. This means, in simple terms, that you don't have to deal with the noise of paying taxes on your earnings annually. Depending on the type of IRA you own, you may never have to. For instance, the IRS does not tax Roth IRA withdrawals, including earnings, if you've held your account for at least five years and you wait until age 59 1/2 to take them. The IRS taxes all traditional IRA distributions, regardless of age and circumstance.
You can generally make the same types of investments in a brokerage IRA as you can in a straight brokerage account. There are some restrictions, however. Check with the firm you have your account with for a complete list. The most common restrictions involve riskier investment plays, such as trading options. You can trade options inside your IRA, but most companies limit your activity.
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