You can buy index funds through a brokerage account, a retirement account, or both

An index fund is just a collection of stocks or bonds that track a market index — you cannot buy one directly from the index itself. Instead, you open an account at a financial institution that sells index funds, deposit money, and place an order. The institution you choose matters because it affects what you pay in fees, what funds are available to you, and how straightforward the account is to manage.

Most people choose between three paths: a brokerage account (which you can open and use anytime), a retirement account like an IRA or 401(k) (which has tax advantages but rules about when you can withdraw), or both. The right choice depends on whether you are saving for retirement or another goal, how much you have to invest, and whether your employer offers a retirement plan.

Key Takeaways

  • Brokerage accounts let you buy index funds anytime with no contribution limits, but you pay taxes on gains and dividends each year.
  • Retirement accounts like IRAs and 401(k)s defer or eliminate taxes on gains, but have annual contribution limits and rules about when you can withdraw without penalty.
  • Low-cost brokerages like Fidelity, Vanguard, and Schwab charge little or nothing per trade and offer thousands of index funds.
  • Your employer's 401(k) plan may match a portion of what you contribute, which is information programs and usually the best first place to invest.
  • You can and should use both a retirement account and a brokerage account if you have money left over after maxing out retirement contributions.

Brokerage accounts: no limits, but you pay taxes yearly

A brokerage account is a regular investment account you open at a bank or brokerage firm. You can deposit as much money as you want, buy and sell whenever you want, and withdraw whenever you want. There are no annual contribution limits and no rules about your age or income.

The trade-off is taxes. Every time your index fund pays a dividend or you sell shares at a profit, you owe federal income tax on that gain in the year it happens. This is true even if you do not withdraw the money. Over decades, these yearly taxes can reduce your total return compared to a retirement account.

Open a brokerage account if you are saving for a goal that is not retirement (a house down payment, a car, education), or if you have already maxed out your retirement account contributions for the year and still have money to invest.

401(k) plans: employer match and tax deferral

If your employer offers a 401(k) plan, this is usually the best place to start investing. You contribute money directly from your paycheck before taxes are taken out, which lowers your taxable income for the year. Your money grows tax-free until you withdraw it in retirement, typically after age 59½.

Many employers match a portion of what you contribute — commonly 50 cents to a dollar for every dollar you put in, up to a certain percentage of your salary. This match is information programs and an when ready return on your investment. If your employer offers a match, contribute enough to get the full match before putting money anywhere else.

The downside is rules. You cannot withdraw money before age 59½ without paying a 10 percent penalty plus income tax on the withdrawal (with narrow exceptions). You also have a limited choice of funds — your plan offers only the funds your employer selected, which may or may not include low-cost index funds.

Traditional and Roth IRAs: tax advantages without an employer

An IRA (Individual Retirement Account) is a retirement account you open on your own, without an employer. You can open one at any brokerage — Fidelity, Vanguard, Schwab, or many others. You have full control over which index funds to buy, and you can choose between a Traditional IRA and a Roth IRA.

With a Traditional IRA, you contribute money before taxes (if you meet income limits), your money grows tax-free, and you pay income tax when you withdraw in retirement. With a Roth IRA, you contribute money after taxes, your money grows tax-free, and you pay no tax on withdrawals in retirement. Both have the same annual contribution limit — for 2024, you can contribute up to $7,000 per year if you are under 50, or $8,000 if you are 50 or older. These limits reset each January.

Like a 401(k), you cannot withdraw before age 59½ without penalty, with some exceptions (Roth IRAs have slightly more flexible rules). The advantage over a 401(k) is choice — you can buy any index fund offered by your brokerage, not just the ones your employer selected.

Choosing a brokerage: fees and fund selection matter

Once you decide what type of account to open, you need to choose where to open it. The major low-cost brokerages are Fidelity, Vanguard, Charles Schwab, and Merrill Edge. All four charge zero commission on stock and index fund trades, offer thousands of index funds, and have no account minimums.

The main differences are in their own index funds. Vanguard and Fidelity both offer their own low-cost index funds (Vanguard Funds and Fidelity Funds), and both allow you to buy index funds from other companies too. Schwab offers Schwab index funds plus thousands of others. Merrill Edge is owned by Bank of America and integrates with their banking platform if you already bank there.

For most people, any of these four is a good choice. If you are just starting out and want simplicity, Vanguard or Fidelity are the most straightforward. If you already have a relationship with a bank, check whether they offer brokerage services — you may be able to consolidate everything in one place.

How to decide: retirement account, brokerage, or both

Start with your employer's 401(k) if one is available. Contribute enough to get the full employer match — this is the highest may provide return you will get. If your employer does not offer a match, contribute what you can afford, but do not feel pressured to max it out before opening an IRA.

Next, open a Traditional or Roth IRA at a brokerage of your choice and contribute what you can. An IRA gives you more control over fund selection and lower fees than most 401(k) plans. If you have money left over after maxing out your IRA contribution for the year ($7,000 or $8,000 depending on age), open a brokerage account and invest there.

If you do not have an employer 401(k), start with an IRA. You get the same tax advantages and full control over your investments. Once you max out your IRA, use a brokerage account for additional savings.

Common mistakes to avoid when opening an account

Do not open an account at a bank's investment desk unless you have a specific reason. Banks often charge higher fees and offer fewer index fund choices than dedicated brokerages. If your bank offers a 401(k) plan through your employer, that is fine — use it for the match. But for an IRA or brokerage account, go to Fidelity, Vanguard, Schwab, or Merrill Edge.

Do not assume your 401(k) plan has low-cost index funds. Some plans offer only actively managed funds with high fees. If your plan is expensive, still contribute enough to get the employer match (information programs), then put additional savings in an IRA where you control the funds and fees.

Do not confuse contribution limits with account limits. You can have multiple IRAs, but your total contributions across all IRAs cannot exceed the annual limit ($7,000 or $8,000 in 2024). You can have multiple brokerage accounts with no limit. Many people keep one IRA and one brokerage account for simplicity.

Frequently Asked Questions

Can I have both a 401(k) and an IRA at the same time?

Yes. You can contribute to both in the same year, but your IRA contribution limit does not change — it stays at $7,000 or $8,000 total across all IRAs. If you have a 401(k) through your employer, you can still open and contribute to a Traditional or Roth IRA, though income limits may explore to Traditional IRA deductions if your income is high.

What is the minimum amount I need to open an account?

Most brokerages have no minimum to open an account. Fidelity, Vanguard, Schwab, and Merrill Edge all let you open an account with zero dollars and add money later. Some index funds have minimums (often $1,000 or $3,000 for the first purchase), but many brokerages now offer fractional shares, which means you can buy a portion of a fund with any amount of money.

Should I open my IRA at the same place as my 401(k)?

Not necessarily. Many people keep their 401(k) with their employer's plan provider and open an IRA at a separate brokerage with lower fees and more fund choices. This is fine — you can manage both accounts separately. Some people prefer consolidating everything in one place for simplicity, which is also fine. Choose based on where you get better fees and fund selection.

Can I move money from a 401(k) to an IRA?

Yes, through a process called a rollover. If you leave your job, you can roll your 401(k) balance into a Traditional IRA at a brokerage of your choice. This gives you more control over investments and usually lower fees. You cannot roll a 401(k) into a Roth IRA directly, but you can do a conversion, which has tax consequences — consult a tax professional before doing this.

Do I need a lot of money to start investing in index funds?

No. With fractional shares, you can start with any amount — even $50 or $100. Many people set up automatic monthly contributions from their paycheck or bank account, which builds wealth over time without requiring a large lump sum upfront.