Retirement accounts like IRAs and 401(k)s allow a person to accumulate savings free of taxes. Money put in such a retirement account is not taxed until it is taken out. This is hopefully only done when the person has retired and their tax rate on regular income is at its lowest in years. Many kinds of investments are allowed in an IRA. These include stocks, bonds, annuities, mutual funds, exchange traded funds (ETFs), unit investment trusts (UITs), and real estate. Which are the best investments for your retirement account?
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Dividend Stocks for Your IRA
The point of having a retirement account is to shelter your investments from taxes over the years. Thus the ideal retirement account investments are those that would suffer the most from taxation over the years. Dividend stocks come to mind first of all. If you are going to hold your Microsoft, Coca Cola, or Apple stock for decades you will not have to deal with capital gains on your shares until you start to sell them for retirement income. However, even with an efficient dividend reinvestment plan you are paying taxes on your dividends year in and year out. Putting this type of investment in an IRA can be a good idea.
Use Your Retirement Account for an Actively Managed Portfolio
A goal of every investor is to discover a stock that is set to grow in multiples like Microsoft did in the beginning. However, many of these stocks grow to become mature companies (like Microsoft) and then their growth levels off. An investor who actively manages their portfolio will typically sell the stock at that point as they look for new growth stock opportunities. If they manage to do this repeatedly they can grow their portfolio very well. However, every time they sell a stock that has appreciated they are clipped with capital gains taxes on that investment. A way to avoid that issue is to invest in the stock within a retirement account. The only taxes in that case will happen just once when money is withdrawn from the account, not year after year. The same approach applies to any actively managed investments.
Investments Not Allowed in a Retirement Plan
There are five categories of investments you cannot hold in an IRA. This list includes life insurance with the exception of a very small policy for a plan participant where the death benefit is merely incidental in comparison to the total funds in the plan. Collectables and antiques are also not allowed. Nor is real estate allowed if it is for personal use. And with the exception of a few very pure gold coins, collectable coins are not allowed in a retirement plan either.
Retirement Accounts and Derivatives
A retirement account is meant to shelter an investment from taxes over the years. It is not meant for speculative activity. Thus one of the rules is that funds in your retirement account cannot be used as collateral for a loan. This rule excludes many derivative investments that would typically require a margin account such as naked calls and puts in options trading. The one options strategy that is commonly allowed is the covered call. Many long term investors use covered calls to gain income from a stock that they own. Ownership of the stock means that the person is not using it as collateral for a loan. If the stock goes up in value they may need to sell it. But since it is sheltered in a retirement account they will not be stuck with paying capital gains taxes on a stock that they have owned for years. They will now have cash which they can reinvest. Again, taxes will only be due when they cash out during their retirement years.
Originally published at https://profitableinvestingtips.com on August 31, 2023.
Investments for Your Retirement Account was originally published in InsiderFinance Wire on Medium, where people are continuing the conversation by highlighting and responding to this story.
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