Nothing is certain in this world except for death and taxes. For many dividend growth investors, this could be characterized as a feeling that they are being taxed to death. While I keep most of my assets in taxable brokerage accounts, I am always on the lookout to legally minimize my investment taxes as much as possible. In fact there is a way to invest in dividend paying stocks without ever having to pay taxes on your investment.
The Roth IRA allows individuals who have earned income in a given year to contribute up to $5000 in after-tax dollars to their retirement account. There is a catch-up contribution of $1000 for individuals who are 50 years of age or older. While contributions to Roth IRA’s are not deductible on your tax returns, earnings and principal distributions are tax free once certain age and time requirements are met. Roth IRA’s allow for tax-free compounding of capital over time.
The earned income includes compensation from salary, wages, commissions, bonuses and alimony. Income from interest, dividends, annuities or pensions does not count as earned income in the eyes of the IRS.
The contribution limit for a Roth IRA is the same as the contribution limit for a regular IRA. However the amount that can be contributed to a Roth IRA is the amount remaining after subtracting any contribution made to a regular IRA. This means that if you contributed the maximum allowable amount to your regular IRA of $5000, you would not be able to contribute anything to a Roth IRA in that year.
There are no required minimum distribution rules for Roth IRAs. However, there are phase-out income limits for high earning taxpayers, which reduce the opportunity to use this tax advantaged investment account.
In order to avoid paying taxes on distributions from Roth IRA accounts, investors need to become acquainted with the qualified nontaxable distribution rules.
According to the IRS, qualified nontaxable distributions for Roth IRAs are those made at least 5 years after the taxpayer’s first contribution to a Roth IRA and made:
- After the taxpayer become 59.5 years old
- To a beneficiary after the death of the taxpayer
- Because the taxpayer becomes disabled
- For a use of a first time homebuyer
The biggest benefits of a Roth IRA are the long-term, tax-free compounding of capital, the fact that qualified distributions are tax-free and the fact that there are no required minimum distributions. Another little known fact behind Roth IRAs is that direct contributions may be withdrawn at any time. This makes them a perfect investment vehicle for investors who plan on retiring early and living off dividends before they reach typical retirement ages of 60 years.
I hold several stocks in Roth IRA accounts. Given the fact that the limit is $5000/year and that I typically purchase stocks in $1000 increments, I do not own a whole lot of different companies in my Roth. The five companies I plan to add to my Roth IRA in 2011 include:
Philip Morris International Inc. (NYSE:PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. Yield: 4.30% (analysis)
Johnson & Johnson (NYSE:JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Yield: 3.50% (analysis)
The Procter & Gamble Company (NYSE:PG) provides consumer packaged goods in the United States and internationally. Yield: 3.40% (analysis)
PepsiCo, Inc. (NYSE:PEP) engages in the manufacture, marketing, and sale of foods, snacks, and carbonated and non-carbonated beverages worldwide. Yield: 3.20%
Kinder Morgan, Inc.(NYSE:KMI) owns and operates energy infrastructure in the United States and Canada. The company operates in six segments: Products Pipelines-KMP, Natural Gas Pipelines—KMP, CO2—KMP, Terminals—KMP, Kinder Morgan Canada—KMP, and NGPL PipeCo LLC. Yield: 4.60%