Dividend Stocks and Your Roth IRA

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There are many Roth IRA investment options. It can seem overwhelming. You might not know where to invest, from mutual funds to stocks and bonds to exchange traded funds (ETFs ),). You can also invest in crypto as well as certificates of deposit (CDs). How do you decide what to put in your Roth IRA?

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But what about dividend stocks in a Roth IRA. Sure, why not?

Let’s see why you might choose to invest in dividend stocks for your portfolio.

What are Dividend Stocks?

Dividend stock comes from companies that regularly pay shareholders, usually in cash payments. Companies that offer dividends may also offer stock options to investors.

Most companies pay dividends on a quarterly basis, four times per year. Some companies pay their dividends on a semi-annual basis (twice per annum), once per year (once per annum), or on a random schedule. These are known as “irregular distributions.”

For example, a company that pays $3 in annual dividends and has a stock price of $100 would have a dividend yield of 3%.

There is no right or wrong way to receive your dividends. If you plan to use your dividends to cover monthly expenses, you might want to receive them every month. You can reinvest dividends in company stock or wait until you are retired to reap the benefits of your investments.

What is a Roth IRA, and how do you get it?

A Roth individual retirement account (IRA), allows you to invest after-tax dollars, and receive tax-free growth and withdrawals when your time comes. There are some restrictions on Roth IRAs. You cannot invest in Roth IRAs for everyone.

Your income level will determine your ability to invest in a Roth IRA. To be eligible to invest in a Roth, you must have a minimum income. If you’re single, your modified adjusted gross income (MAGI), which is your adjusted gross income (AGI) plus a few other things (like exempt or excluded income and certain deductions), must be under $144,000 in 2022 to contribute to a Roth IRA. On the other hand, if you’re married and file jointly, your MAGI must be under $214,000 in 2022.

You’re also limited in your total contribution — $6,000 if you’re under age 50 and $7,000 if you’re age 50 or older. You cannot contribute more to any other IRAs than you can for them all.

You must also be aware of withdrawal rules to get the best out of your investment. Withdrawals must be taken after age 59 1/2 and five years after you’ve purchased your securities. There are exceptions to the early withdrawal penalties. You can withdraw your money earlier if you are making a home purchase, paying college expenses, or having expenses related to the birth, adoption, or adoption of a child.

Pros & Cons of a Roth IRA

The pros and cons of a Roth IRA may seem obvious: you save now, and money compounded for later. Let’s look at a few to make sure you choose the right investment for you.

Pros of a Roth IRA

Let’s first look at the benefits of a Roth IRA.

  • Tax-free growth Because you pay tax upfront, your earnings grow tax-free through a Roth IRA. Withdrawals are exempt from taxes, so you can withdraw more, especially if your retirement tax rate is higher.
  • No required minimum distributions: Unlike a traditional IRA, which requires that you take money out of the IRA starting at age 72, you do not have to pull out money from a Roth IRA by a certain age.
  • Withdrawal options You can withdraw money for any reason, including first-time home purchases or college expenses.
  • Good for higher tax brackets Do your retirement tax rates seem higher? If this is the case then Roth contributions may be your best option to pay taxes early. If you believe your retirement tax rate will be lower, traditional contributions may be a better option to defer taxes.

Cons of a Roth IRA

While most professionals love a Roth IRA, there are still a few things to consider before you make the decision to take the Roth IRA route. Let’s take a closer look at

  • Upfront taxes It’s possible to feel like your money is being sucked through your fingers, instead of paying the taxes off top, as with a traditional IRA. It is a good idea for you to decide whether you want to pay taxes now, or later.
  • Income Limits: If your income exceeds the limit, you are out of luck. If you reach the income limits, you can phase your investment out. This means you can contribute slightly less than the maximum amount.
  • Low maximum contributions: As mentioned above, you can only contribute $6,000 in 2022. Even though you can also contribute $7,000 if you’re 50 or older, it’s still far less than what you can contribute through other retirement savings plans. For example, For 2022, you can contribute elective contributions of $20,500 to a 401(k).
  • You’re on your own: There’s no employer encouraging you to sign up for the company 401(k) when it comes to a Roth IRA. You must take responsibility for your investment decisions.

Taxes on Roth IRA Dividends

You can avoid paying annual taxes by investing in a Roth IRA. However, if you want to retire earlier than age 59 1/2 , a taxable brokerage account may be a better option because you can access your earnings at any time. However, in a regular investment account, you’ll either pay short-term capital gains, which is a tax levied on assets held for a period of 12 months or less. They are taxed like ordinary income — anywhere from 10% to 37%, depending on your income level.

Long term capital gains , is a tax that is applied to assets that have been held for more than one year. The long-term capital gains tax rates are 0%, 15% and 20% and depend on your income and are much lower than the ordinary income tax rate. You might be eligible for the 0% long term capital gains rates if your income is low. In this case, you won’t be subject to tax on your dividends.

If you have your money in a Roth IRA ,, you will not be subject to tax on dividends that you reinvested in a Roth IRA. Dividends are not subject to tax on an annual basis. However, if you have a regular taxable investment account your dividends will be taxed each year when you take them.

Finding Dividend Stocks for Your Roth IRA

How can you choose the best dividend stocks for your Roth IRA. You’ll be investing for retirement over many decades so it’s important to choose stable companies with strong metrics. The Dividend Kings, which have increased their dividends for the past 50 years in a row, or the Dividend Aristocrats, might be one way to identify companies that fit your goals of dividend growth over time.

Learn more: Dividend Kings vs. Dividend Aristocrats

Take a look at these Dividend aristocrats that you might want to add to your portfolio:

Should You Invest in Dividend Stocks in Your Roth IRA?

So, should you build a dividend stock portfolio through a Roth IRA?

The short answer is that it all depends on your investment goals and preferences. You should also realize that dividend stocks might not offer the same returns as growth stock, but may have a much higher return.

Learn more: Are Dividend Stocks Worth It?

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