Tax-advantaged retirement accounts are nothing new. Employer-sponsored pension plans have been around since the the turn of the 20th century. Individual retirement accounts have a shorter history. Congress first authorized IRAs in 1974, making it possible for people to set aside a portion of their earned income for their golden years without paying income taxes on contributions. You can put everything from stocks to shares of a real estate investment trust in your IRA.
Stock represents an ownership position in a company. You might buy a particular stock because you think its market price will increase, resulting in a capital gain, or you might buy it because it pays a regular quarterly dividend, resulting in current income. The Internal Revenue Service considers capital gains and dividends taxable income. One benefit of holding your stocks in an IRA is tax deferral. Income that is produced inside your IRA is not subject to current income taxation. This includes income from both dividends and capital gains.
Real Estate Investment Trusts
Real estate investment trusts are investment companies that own large-scale, income-producing properties, such as apartment complexes, shopping malls, commercial buildings and hotels. A REIT buys, develops and operates the properties, then collects rent from the tenants and passes on a portion of its profits to trust owners in the form of dividends. REIT dividends might include ordinary income, capital gains and return of capital, all of which are taxed at different rates. Since income produced by investments in your IRA are not subject to current federal income taxes, you don't have to worry about what portion of your REIT dividends came from what source.
You can take a tax deduction for contributions to your traditional IRA, and all of the growth that occurs in your traditional IRA happens without resulting in a current income tax liability. That doesn't mean the IRS doesn't want its cut. The IRS considers all of the money you withdraw from your traditional IRA to be ordinary income, regardless of how the money got into the account. That means any long-term capital gains from REITs or stock trades that would have been taxed at the lower long-term capital gain rate will be taxed according to your tax rate at the time of withdrawal.
All contributions to a Roth IRA must be made with after-tax dollars. You don't get to take a tax deduction for these contributions. You still get tax deferral on the growth of your stock and REIT investments, and you can withdraw the amount you put in at any time for any reason without paying income taxes and without a tax penalty. Even better, once you reach age 59 1/2 and have had your Roth IRA for at least five years, all of your withdrawals, including growth on your investments, is tax-free.
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.