Brokerage account vs. IRA: What's the difference?

On the surface, brokerage accounts and individual retirement accounts (IRAs) can seem similar. Both allow you to invest in assets such as stocks, bonds and mutual funds with the expectation that your money will grow over time.

So, is an IRA a brokerage account or is a brokerage account an IRA? No, they're not the same—these two account types have different goals, tax implications, investment options and more. The most straightforward distinction is that a brokerage account is a general investment account while IRAs are explicitly for retirement saving. While some brokerage accounts may be set up as IRAs, for the purposes of this article we will use the term brokerage account to represent a taxable account, not a tax-deferred account such as an IRA.

If you're trying to decide whether to put your money in one or the other (or both), you'll want to factor in your time horizon and objectives. Here's a bit more comparing a brokerage account vs. IRA and how each could meet your needs.

A brokerage account is an investment account offered by a financial institution that can include securities such as stocks, bonds, mutual funds and exchange-traded funds (ETFs). They may also involve securities that involve taking greater risks to get greater rewards, such as options and cryptocurrency.

When you open a brokerage account, the money you put into it goes toward the purchase of investment shares based on your preferences. These accounts can be self-directed—that is, you can choose the assets in which you invest—or they can be managed by a broker. Your financial institution may even offer an automated service, or "robo-advisor," that chooses how you invest based on your age and objectives.

Depending on where you open the account, you may have to pay a commission or fee when you make trades. You may also be charged for investment management services, either as a percentage of your assets or as a flat fee.

Brokerage accounts differ from retirement savings accounts in that they offer maximum flexibility. You have access to a wide range of financial products, and you can withdraw your money at any time without incurring a penalty from the IRS. They can be a good choice if you're investing money that you may need to withdraw before you retire.

As tools for building your retirement savings, IRAs offer tax advantages you won't find with a brokerage account. IRAs are classified as "qualified" accounts under the tax code, like 401(k)s and other retirement plans. The main difference is that IRAs exist outside of an employer plan and have their own contribution and withdrawal requirements. They also offer more investment choices than many 401(k)-style plans.

As with a brokerage account, you can open an IRA in a number of places, including brokerage firms, fund companies, insurance providers and banks. Most allow you to invest in individual stocks and bonds as well as mutual funds and ETFs. You may even have options to allocate your IRA contributions toward certificates of deposit (CDs) and real estate investment trusts (REITs).

Brokerage accounts and IRAs are both considered effective ways to grow your assets over time and achieve your long-term goals. To figure out how one or both of them could be a good fit for your overall financial strategy, it's important to understand the main differences.

Nearly 42% of U.S. households owned IRAs in 2022. A top reason for this level of popularity? The potential tax benefits that both traditional and Roth IRAs offer.

Brokerage accounts are funded with your post-tax dollars, money that you've already paid income tax on. For any earnings your money makes in the account—such as capital gains, dividends or interest—you'll be subject to taxes on them annually. When you withdraw money from the account, you may also incur taxes.

Traditional IRAs, in contrast, are built on pre-tax contributions and grow earnings on a tax-deferred basis. That means you won't need to pay annual taxes on capital gains, dividends or interest as long as your money stays in the account. When you withdraw the money, the entire amount will be subject to your ordinary income tax rate at that time. This delayed taxation could be advantageous if you're in a lower tax bracket at withdrawal time than when you contributed. One important restriction, though, is that you may face a tax penalty if you withdraw money before age 59½.

Another version of an IRA called a Roth IRA has a different tax setup that can be appealing as well. With a Roth, you contribute post-tax dollars, but then your account earnings have the possibility of growing tax-free. You can withdraw your contribution amount from a Roth at any time without incurring taxes or penalties, and once you've owned the account for at least five years and have reached age 59½, withdrawals of your earnings are also tax- and penalty-free.

Brokerage accounts have no investment amount restrictions, annual or otherwise. You can put in as little or as much as you're comfortable with.

Favorable tax treatments aside, IRAs do have some drawbacks compared to brokerage accounts when it comes to how much money you can put into them. Traditional and Roth IRAs have annual contribution limits:

• 2023 contribution limit to all IRAs combined: $6,500.
• 2024 contribution limit to all IRAs combined: $7,000.
• If you're age 50 or older: You can do a bit more via catch-up contributions; you can put in up to an additional $1,000.

One thing to think about is that the IRA contribution limit is separate from the cap placed on workplace retirement plans. That makes them a potentially sound choice if you've maxed out your 401(k) allocation and are looking for another tax-advantaged vehicle for your investment dollars.

Another advantage of brokerage accounts over IRAs is that you can take some or all of your money out at any time without worrying about potential IRS penalties. That isn't the case with IRAs, which have restrictions based on your age because the money is meant to stay put until your retirement.

When you withdraw money from an IRA before age 59½, you'll typically face a 10% penalty on the entire withdrawal amount. And if it's a Roth account, you'll also need to have owned it for at least five years (although as noted earlier, you can withdraw your Roth IRA contributions, but not earnings, at any time without penalty). These fees are on top of any income tax you may owe on the money as well.

The IRS does have some early IRA withdrawal exceptions where you won't have to pay the penalty if you meet certain circumstances. These are some common ones, but there are more:

• You experience a total and permanent disability
• You use the money to pay for eligible higher education expenses
• You're a qualified first-time homebuyer (up to $10,000 allowed)
• You use the money to pay for health insurance premiums while unemployed

One more distinguishing characteristic between brokerage accounts and IRAs is that traditional IRAs—although, importantly, not Roth IRAs—come with rules about when you have to start taking your money out. These are called required minimum distributions (RMDs), and the ages currently are designated by Secure Act 2.0.

From 2023 to 2032, the age you have to take your first RMD is 73; starting in 2033, it'll be 75. The amount of those withdrawals is based on your statistical life expectancy as determined by the IRS.

Roth IRAs don't have RMD rules for the account owner during their lifetime, but beneficiaries who inherit a Roth IRA will have to abide by RMDs. It may make sense for you to convert all or part of your traditional IRA to a Roth IRA, but if you're wanting to make an investment that you don't ever have to draw down, a brokerage account could meet that need.

To be sure, IRAs come with some strings attached. But their unique tax advantages make them a compelling choice if you don't plan to access your money until retirement. Taxable accounts, however, could suit you if you've reached your limit on qualified contributions or you may need to tap your money earlier in life.

Need help deciding which accounts are right for you? Talk with a financial advisor who can help design an investment strategy built around your specific needs.