Ready to Start Investing? One Big Mistake to Avoid

It's great to invest -- but it's important to choose the right place to put your money.

Any money you need for near-term expenses, like a down payment for a home, should be kept in a savings account. But if you have funds you're setting aside for a far-off goal, like retirement, it often pays to invest that money so it can grow into a larger sum.

In that regard, you have choices. You could open a traditional brokerage account and invest your money there. Or, you could put your money into an IRA, which is an individual retirement account.

You may be inclined to just open a regular brokerage account. That way, you won't be restricted as you might be with an IRA. But if you pass up the opportunity to invest in an IRA, you might regret it in the long run.

Wouldn't you rather pay the IRS less?

IRAs come with annual contribution limits that change from year to year. This year, you can put up to $6,000 into an IRA if you're under the age of 50. If you're 50 or older, that limit rises to $7,000.

You'll also be penalized to the tune of 10% if you remove funds from your IRA before age 59 1/2. The reason? An IRA is supposed to serve as a retirement account, so the IRS doesn't want you taking out money too soon. That said, there are some exceptions that allow you to take an early IRA withdrawal, such as using funds for a first-time home purchase.

With a regular brokerage account, you can put in as much money as you want each year and you can remove funds no matter what age you are. But there's one thing you'll miss out on if you choose a regular brokerage account over an IRA: a major tax break.

With an IRA, the money you contribute goes in on a pre-tax basis (to be clear, for the context of this discussion, we're talking about traditional IRAs, not Roth IRAs). This means that if you put $6,000 into your IRA this year, that's $6,000 of earnings the IRS will not be able to tax you on. If you're in the 22% tax bracket, not being taxed on $6,000 of your income will result in about $1,320 of tax savings.

What’s more, if you sell investments at a profit in a regular brokerage account, you'll be liable for taxes the year you take those gains. With an IRA, your investment gains are tax deferred, which means you don't incur a tax bill year after year. Rather, you pay your taxes on that money when you take withdrawals during retirement.

Start with an IRA

Perhaps you're able to save and invest more than $6,000 or $7,000 a year. If so, you're in a great spot. In that case, it pays to max out your IRA contribution for the year, and then invest the rest of your money in a traditional brokerage account.

But don't pass up the chance to fund an IRA because of the restrictions involved. If you do, you could end up losing out on a lucrative tax break.

The one exception to this is if you're contributing to a 401(k) plan through your employer and your income is too high given the IRS limits. In that case, you may not be eligible for a tax break for funding an IRA. But otherwise, it pays to put money into that IRA -- and use it as a means of lowering your tax bill.