Most of us know we should save and invest more for retirement, but we also worry about the tax implications those investments will have. The good news is the growth and dividends we earn through individual retirement accounts are not taxable until we begin making withdrawals. These accounts can grow as large as your investments will allow without any threat of Uncle Sam sharing in the profits.
According to IRS Publication 590, you are not responsible for capital gains taxes on earnings in an IRA. Stock appreciation and dividend payments continue just as they would in any other account, except they are not taxable at the time of return. You will only be responsible for taxes at the time of withdrawal or distribution. These will be calculated based on the type of retirement account owned, your age and whether the distribution is considered a qualified distribution.
Dividend Reinvestment Programs
The most effective method available to maximize the earning potential of dividends is a dividend reinvestment program. This allows the dividend paid on a particular stock to be reinvested automatically into shares of that company. If the dividends don't equal the dollar value of a full share, partial shares are purchased. Best of all, these purchases are made without incurring brokerage fees. Most investment brokerage houses including discount brokerages offer some type of dividend reinvestment program.
Dividends are taxed as regular income when you withdraw them from a traditional IRA. You must take your first distribution by age 70 1/2. To calculate the minimum distribution, you must divide the total dollar value of the account by your life expectancy and the life expectancy of your beneficiary. You may be able to take an early withdrawal if you are a first-time home buyer, using the funds for qualified medical expenses or buying health insurance if unemployed.
You are not taxed on qualified withdrawals from a Roth IRA. This means all of the money you earn in a Roth is essentially tax-free. Certain conditions must be met to ensure your distribution is qualified. First, the funds must have been in the account for at least five years before withdrawal. Second, you must meet a qualifying condition such as having a permanent disability, being a first-time home buyer or being over age 59 1/2.
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