Investments Personal Finance Retirement Taxes

Compare: Tax differences between brokerage accounts, Roth IRAs, and Traditional IRAs

In summary:
Brokerage accounts are taxed twice (when the money is earned as income and when a profitable sale is made in the account).
Roth IRAs are taxed when the money is earned as income (and not when it is taken out of the account).
Traditional IRAs are taxed when the money is taken out of the account (and not when the money is earned as income).

FICAIncome taxes (federal and state)Annual Contribution LimitsEarningsDistributionsMinimum Distribution Age (without penalty)
Brokerage AccountAlready paidAlready paidN/ATaxed as income (short-term capital gain) or long-term capital gainNot taxableN/A
Roth IRAAlready paidAlready paid$6,000;
$7,000 if age 50 or over (2020)
Not taxable (unless distribution is premature)Not taxable (unless distribution is premature)59.5
Traditional IRAAlready paidDeferred$6,000;
$7,000 if age 50 or over (2020)
Not distinguished from contributionsTaxed as income for federal and state purposes59.5

Real-life application:
Person A is under 30 years old and will make $50,000 of gross (pre-tax) wages this year. They want to put $5,000 into an individual investment account.

Scenarios
Brokerage account: They put $5,000 into a brokerage account. They already paid tax on the money and won’t get a tax deduction next tax season for this year. Their Adjusted Gross Income (AGI) for the year is $50,000. They will realize tax on any gains in any holdings they sell in the year they sell them.

Roth IRA: They put $5,000 into a Roth IRA. They already paid tax on the money and won’t get a tax deduction next tax season for this year. They won’t realize any more tax on this money as long as they take it out from the Roth IRA after the later of age 59.5 or the account is 5 years old. Their Adjusted Gross Income (AGI) for the year is $50,000.

Traditional IRA: They put $5,000 into a Traditional IRA. They already paid tax on the money and will get a tax deduction of $5,000 next tax season for this year. They will realize federal and state tax on this money when they take it from the Traditional IRA after age 59.5. Their Adjusted Gross Income (AGI) for the year is $45,000.

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