When you are ready to start thinking about saving for retirement, you have options in two main categories: taxable accounts and Individual Retirement Accounts (IRAs). Taxable accounts are general tools for saving and investing. IRAs are built with retirement in mind. Each type of account has distinctive features.
The Differences Between Taxable Accounts and IRAs
Taxable Account IRA
A taxable account is a retirement-focused account. It offers tax advantages to encourage contributions. IRAs come in different forms, including traditional and Roth.
Diversity
Investing in a taxable brokerage account can provide tax diversity. This is the reduction of risk by spreading savings and investment assets among various types of accounts. By using multiple types of accounts with varying tax treatments, investors can be more flexible in the timing and tax implications of withdrawals.
Withdrawals
One of the main drawbacks of traditional IRAs is that you are penalized for early withdrawals. If you are saving for retirement and think you might need some savings in the long term before age 59 and a half, you can avoid the early withdrawal penalty by opting for a taxable account.
Taxes
IRAs are tax-advantaged because they allow you to defer or skip taxes on the money you deposit until you withdraw it. With traditional IRAs, contributions are tax-deductible in the year you make them. Taxes are deferred until you withdraw the money in retirement, which means you don’t pay taxes on the gains over the years. Long-term capital gains on investments sold from taxable accounts are subject to a 15% capital gains tax. For some investors, this rate may be lower than their federal income tax rate. For this reason, a taxable brokerage account may be a better option for wealthy individuals in high tax brackets compared to traditional IRAs, where withdrawals are taxed as ordinary income.
Contribution Limits for IRAs
The Internal Revenue Service (IRS) sets a limit on how much you can contribute to an IRA each year. In 2022, you can contribute $6,000 annually and $7,000 if you are age 50 or older. In 2023, you can contribute $6,500, and if you are age 50 or older, you can contribute $7,500.
Income Limits for Tax-Deductible Contributions
Although there are no income limits on tax-deductible contributions to traditional IRAs, there are income limits to receive a tax deduction in the year of contribution if you (or your spouse) are covered by a workplace retirement plan. For example, a couple filing jointly and covered by their employer’s retirement plan will see their tax deduction phased out starting at $109,000 in 2022 and $116,000 in 2023.
Roth IRAs
Roth IRAs are similar to traditional IRAs, but there are distinct differences. With a Roth, your contributions are funded with after-tax dollars, meaning you do not receive a tax deduction in the year of contribution. However, your investment gains grow tax-free over the years, and there are no income taxes when you withdraw your money in retirement.
You can also withdraw your contributions from a Roth at any time, including before age 59 and a half, but you cannot withdraw your earnings without penalty until the account is at least five years old and you are at least 59 and a half years old.
Limits
The annual contribution limit for Roth IRAs is the same as that for traditional IRAs. However, there are income limits to be eligible to contribute to a Roth. You can only make Roth IRA contributions if you earn less than $144,000 as a single applicant in 2022 ($153,000 in 2023), and $214,000 if you are married and filing jointly in 2022 ($228,000 in 2023).
In short, you do not get a tax deduction upfront with a Roth IRA, but your withdrawals in retirement are tax-free. However, if you earn a high income, the income limits may prevent you from contributing to a Roth.
Which is right for you?
There are some things to consider before choosing the best type of account for you. Should you invest all your long-term savings in an IRA? When is it better to use taxable investment accounts? Or is it better to use multiple types of accounts? Here is a breakdown of when to invest in a taxable account, a traditional IRA, or a Roth IRA.
Who should invest in a taxable brokerage account?
A taxable brokerage account may be better for you if your income exceeds the IRA contribution limit and you want to invest more conservatively. If you’ve maxed out your IRA contributions, you can open a taxable account for additional savings.
But what if you are not looking for a more aggressive saving method and think you might need to withdraw some of your savings before age 59½? In that case, a taxable account may offer you more flexibility compared to an IRA.
Who should invest in an IRA?
A traditional IRA may be better for you if you need tax deductions to lower your tax bill in your year of contribution. It may also be better if you expect to be in a lower tax bracket after retirement. If you do not need tax deductions from your taxable income or are
Source: https://www.thebalancemoney.com/taxable-accounts-vs-iras-2466429
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