A Roth individual retirement account, or IRA, allows you to place after-tax dollars in a tax-advantaged account. Although you must pay federal income taxes on the money you contribute to your Roth IRA, all of the taxes on the growth of the account is deferred, and if you leave the earnings in your account for at least five years you may withdraw them tax-free once you reach age 59 1/2 years. Another advantage of a Roth IRA is your flexibility to invest in a wide variety of financial products, including stocks.
You may fund your Roth IRA only with cash, but you may use the cash in your Roth IRA account to purchase a wide variety of securities and other financial products, with the exception of those prohibited by federal regulation as determined by the Internal Revenue Service. You may not invest funds from your Roth IRA in collectibles, such as art, alcoholic beverages, gemstones, antiques, rare stamps or coins, with the exception of certain gold and silver coins minted by the U.S. Treasury Department. There is no prohibition against investing in stocks.
A Roth IRA is a special type of trust or custodial account. The custodian must be a financial institution that the IRS has approved to act in that capacity. Approved institutions include banks, savings and loan associations, federally insured credit unions, life insurance companies, mutual fund companies and investment brokerage firms. The type of financial institution that serves as custodian for your Roth IRA might limit the types of financial products in which you may invest. For example, a bank might allow you to invest only in certificates of deposit and a mutual fund company might limit your options to its own family of funds.
Some financial institutions allow you to direct your Roth IRA. With a self-directed Roth IRA you may choose the types of investments you purchase, including stocks. Any dividends paid by stocks held in your Roth IRA will not be subject to current income taxes. Any capital gains that result from stock trades inside your Roth IRA will not be subject to current capital gains taxes. Keep in mind that even though your stock trades are free from capital gains taxes, you still must pay brokerage fees, which can be expensive if you trade a lot.
Holding stocks in your Roth IRA is not without risks. The market value of your stocks may decrease, resulting in a loss, and you may not claim the loss when you file your federal income taxes. You must leave the earnings in your Roth account for at least five years and be at least 59 1/2 years of age before the earnings qualify for tax-free withdrawal. If you withdraw earnings generated by stocks in your Roth IRA before they become qualified, the earnings will be taxed as ordinary income and you will have to pay an additional 10 percent tax penalty.
- Internal Revenue Service: Publication 590, Individual Retirement Account
- Internal Revenue Service: Publication 590, Investment in Collectibles
- Internal Revenue Service: Publication 590, What Is a Roth IRA?
- Internal Revenue Service: Publication 590, Are Distributions Taxable?
- CNN Money: Trading Stocks in Your IRA
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.