One of the valuable features of an individual retirement account is that it shields your investment earnings from taxes. If you own a Roth IRA, you can take out these earnings tax-free once you reach a certain age. However, you’ll have to shell out taxes on money you siphon out of a traditional IRA. Dividends might be responsible for a substantial portion of your IRA earnings.
A corporation can issue dividends to shareholders in the form of cash or additional shares. The dividend yield of a stock is its annual payout divided by its current price. Common stocks, which are the voting shares of a corporation, might typically pay dividend yields in the 1 percent to 3 percent range, though many common stocks pay no dividends at all. Preferred stocks pay high, fixed dividends. Yields in the 4 percent to 8 percent range are not unusual, but higher yields are possible. Your IRA custodian will ensure your dividends are properly received and credited to you account.
Mutual Fund Dividends
Mutual funds distribute the dividends, interest and capital gains they earn to shareholders. A mutual fund can pay out dividends any time throughout the year, but must distribute 95 percent of them before year’s end. You can instruct the mutual funds within your IRA to automatically reinvest your dividends in additional shares. Alternatively, you can receive the dividends as cash, which you can then invest in other securities or funds. You don’t have to take any actions to receive dividends. They just appear in your IRA as they are paid.
Dividend Reinvestment Plans
Some corporations offer dividend reinvestment plans in the form of an IRA. Under this setup, you invest your contributions in the shares of the sponsoring corporation. The company automatically reinvests your dividends in additional shares of stock, usually without commission. The Internal Revenue Service allows you to own multiple IRAs, so you can set up a bunch of DRIP IRAs if you like, though it might become a hassle to keep track of them and the annual fees can mount up. You might instead find an IRA custodian willing to reinvest dividends for you, for a fee.
One of the downsides of a traditional IRA is that you’ll have to treat dividends as ordinary income when you withdraw money. The IRS taxes ordinary income at your marginal tax rate, which is the tax on the “last dollar” of annual income. Normally, most dividends in taxable accounts qualify for a lower tax rate, which as of 2013 range from 20 percent to zero, based on your income level. You therefore might end up forking over more taxes on dividends in your traditional IRA. A Roth IRA eliminates the problem because withdrawals are tax-free.
- Corporate-Actions.net: Cash Dividends
- IndexArb: Dividend Yield for Stocks in the Dow Jones Industrial Average
- Forbes: Banking Preferred Stocks With Above Average Yields
- Scottrade: Reinvestment Options for Mutual Funds
- Dow Theory Forecasts: The Pros and Cons of DRIP IRAs
- DRIP Central: Brokerage DRIPs
- Oblivious Investor: Dividend and Long-Term Capital Gain Tax Rates for 2013
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.