What do McDonald's (MCD), Kinder Morgan Management (KMR), National Retail Properties (NNN) and Triangle Capital Corporation (TCAP) have in common? If you say all can be found in Dividend Growth Investing portfolios, you are right ... but here's an even better answer:
All are companies best held in a Roth IRA within a brokerage account.
McDonald's is a DGI favorite that has raised dividends annually for 36 years. Kinder Morgan Management is a master limited partnership that pays distributions in additional shares, thus avoiding many tax issues inherent with MLPs. National Retail Properties is a real estate investment trust and Triangle Capital is a business development company; by law, REITs and BDCs must pay 90 percent of their taxable net income to shareholders.
Investments in those companies -- and hundreds of others on David Fish's list of Dividend Champions, Contenders and Challengers -- can grow significantly within a Roth IRA while giving shareholders enormous tax savings.
Check with the IRS for complete Roth rules, but here's the condensed version: Anybody with income up to $110,000 (or $173,000 for a married couple filing jointly) can fully fund a Roth using post-tax dollars, with a maximum annual contribution of $5,000 (or $6,000 beginning the year the investor turns 50). Most non-working spouses also can open Roth IRAs.
The real magic: Because investments are made with money that already has been taxed, you can reap huge capital gains, dividends and interest within a Roth and not pay another penny to Uncle Sam -- ever!
Let's say you bought $5,000 worth of McDonald's within your Roth IRA in mid-October 2002 and reinvested the dividends these last 10 years. You now would have about $26,000. If you withdraw all of it today, including the $21,000 in capital gains and dividends -- a 420 percent gain during what many have called a "lost decade" for investors -- you will not be taxed on any of it.
I selected McDonald's for my example because it's held by so many DGI practitioners. I could have chosen thousands of other companies. Or mutual funds. Or ETFs. Or bonds. Or CDs. Whatever your investments and whatever your gains within your Roth, you'd have been able to redeem them tax-free.
Do you occasionally like to make short-term trades? You can wheel and deal within a Roth IRA without worrying about taxes. Interested in companies from Canada, such as BCE Inc. (BCE) or Bank of Montreal (BMO)? The country waives its 15 percent withholding tax for U.S. investors if shares are in tax-advantaged accounts. Want to avoid having to take required minimum distributions when you are a septuagenarian or older? The Roth is the only IRA that does the trick.
Are you among the many folks worried about dividends being taxed at much higher rates in 2013 and beyond? Sleep well at night by holding stocks in tax-advantage accounts such as Roth IRAs.
Even if you earn too much money -- a pleasant problem to have -- there are ways you can get a Roth IRA.
For example, if you've rolled over a former employer's 401(k) into an IRA, you then could convert it to a Roth IRA by paying current taxes. If you believe you will be in a higher bracket eventually or simply want tax certainty, this can be an effective strategy. (I am not advocating this for everybody; please consult your tax professional.)
Another useful thing about the Roth IRA: It can serve as kind of an emergency fund. At any time, an investor can withdraw contributions without taxes or penalties. If you bought $5,000 worth of stock within your Roth in 2010 and repeated in 2011 and 2012, you could sell all $15,000 today and take it from the account with no tax consequences. (That applies only to contributions. You can't redeem dividends or capital gains until after five years.)
Although all IRAs are designed for retirement savings, it's comforting to know that your Roth can be tapped for emergencies or necessities. Sorry, a buddy trip to Vegas isn't an "emergency" and a BMW isn't a "necessity"!
What shouldn't go in a Roth? Many foreign countries withhold taxes on investments held by U.S. residents -- even in tax-advantaged accounts -- so do your homework before buying. Also, MLPs that pay distributions in cash seem to be best held in taxable accounts; read related articles by Reel Ken (and the comment streams that follow) before buying MLPs in IRAs.
Some worrywarts fear that Roth IRA rules will be changed by greedy or desperate politicians who want to steal our money. Not a chance. Such a move would be enormously unpopular, probably even political suicide. Senators and representatives of both parties have Roth IRAs, too, as do their families and friends. There will be many more politically palatable ways for our elected officials to reach into our pockets.
If you use a sky-might-be-falling-someday mentality to shun the remarkable Roth IRA, you might as well stash your cash in your backyard bomb shelter.
When should you open a Roth?
First things first: Eliminate high-interest loans, especially credit-card debt. It makes absolutely no sense to invest in a company or mutual fund that might deliver a 5 or 10 percent gain (or even a loss) while paying 18 percent interest on plastic.
A good argument also could be made that, before opening a Roth, you should contribute at least enough to your 401(k) to get the full employer match. Free money is pretty hard to beat.
OK, now you're ready to open a Roth IRA and to start shopping for great companies to fill it. What are you waiting for?