Should you open a brokerage account if you haven’t maximized your retirement plan?
We often hear that saving for retirement is important. Social Security will only replace about 40% of the average wage earner’s salary, which means most older people need more than these benefits to live comfortably. And that’s where personal retirement savings come in.
If you have a 401 (k) plan at work, it pays to sign up and have money deducted from your paychecks to go to that account. If you don’t have access to a 401 (k), you can open an IRA and save there for your retirement.
It is a good idea to try to maximize your pension plan, that is, to contribute enough to reach the maximum contribution allowed for the year. This number changes from year to year. Right now, it’s $ 6,000 for an IRA and $ 19,500 for a 401 (k) if you are under 50. If you are 50 or over, these limits are $ 7,000 and $ 26,000, respectively.
Obviously, maximizing a 401 (k) is a tall order. And maximizing an IRA can be difficult if you earn less income or have a lot of bills to pay. But it’s still a good goal.
But what about investing in a brokerage account? As important as funding your retirement plan is, shouldn’t you also be putting money in a brokerage account?
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It’s all about balance
Some financial experts say it pays to maximize a retirement plan first and then put the remaining money in a brokerage account. The reason? IRAs and 401 (k) offer a plethora of tax breaks. Traditional IRAs and 401 (k) allow your money to go tax free. If you put $ 6,000 in an IRA this year, that’s $ 6,000 of income that the IRS won’t tax you on now.
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Your money grows, tax-deferred, until you make withdrawals at retirement. This means that you will not be taxed on any investment earnings in your account year after year. Rather, you will pay taxes on those earnings and on your withdrawals when you withdraw funds from your IRA or 401 (k) during your retirement.
Roth IRAs and Roth 401 (k) s, on the other hand, do not offer you immediate tax relief on your contributions. But your investments in a Roth account grow completely tax-free, and withdrawals are tax-free in retirement.
Regular brokerage accounts do not offer these tax benefits. If you put $ 1,000 in a brokerage account, there is no tax relief on that money. Any earnings you take in your brokerage account are taxed for the year you earn them. If you sell stocks on a brokerage account for a gain of $ 500 this year, you will owe IRS taxes on that gain when you file your 2022 return.
It’s easy to see why it’s often advisable for savers to maximize a retirement plan before funding a brokerage account. But this may not be the route you want to take.
Although brokerage accounts do not offer tax breaks, they do to do come with one big advantage – unlimited access to your money. If you have to cash out investments in a pinch, you can do so without penalty. With an IRA or 401 (k), you risk a 10% penalty if you withdraw money before the age of 59 1/2 (there are a few exceptions to this rule but you shouldn’t necessarily bet on qualifying for a). Thus, a brokerage account gives you more freedom to withdraw money when you want or need it.
Also be aware that while you can invest in individual stocks with an IRA, the 401 (k) generally limits you to different types of funds (like mutual funds and index funds). If you keep your retirement savings in a 401 (k) but want to own individual stocks, you might want a brokerage account for that reason alone.
It pays to have both types of account
Once you have reached the maximum of a retirement account, opening a brokerage account becomes a matter of course. But even if your IRA or 401 (k) isn’t at the max, it still makes sense to put money into a brokerage account. You may want to put Following of your money in a retirement account for tax breaks, but a brokerage account just might complement that IRA or 401 (k).
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