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A Roth IRA is a tax-advantaged individual retirement account wherein distributions are tax-free and contributions are made with after-tax dollars. Likewise, one can use the deposits to invest in stocks if one is so inclined. In this article, 6 financial experts weigh in on whether or not a Roth IRA is the best place to hold stocks.
A Roth IRA Is An Excellent Vehicle To Hold Onto Stocks
“A Roth IRA is an excellent vehicle to hold onto stocks. Stocks are among the riskier asset classes. With more risk, comes the potential for a great return. Realizing (or selling) large gains from a position that has experienced tremendous growth can lead to a huge tax bill if you invest in a regular taxable account. Because these realized gains are in a taxable account, the investor is required to give away a portion of the growth or capital gain to the taxman. Inside of a Roth IRA, tremendous growth of stocks will not be taxed. Growth is not tax-deferred (like in an IRA or 401k) but is tax-exempt. Roth IRAs are tax-exempt because the money that's been deposited into the account has already been taxed. Upon the sale of the stock positions within a Roth IRA, you do not have to pay taxes on the gains, which also includes any dividends that have been paid to the account. The investor will not encounter any taxes on a withdrawal from the Roth account. An account like a 401k or IRA is considered tax-deferred which means that the investor has an immediate tax deduction on a contribution, but they are taxed at an ordinary income rate when they withdraw money from the account. Managing a stock position with potentially huge gains inside a Roth IRA takes away a lot of the worry of the taxman taking a portion of the gains from the account and allows the investor to hold onto the entire profit.
Another advantage of holding onto a Roth account is the absence of required distributions. Because you are not required to withdraw money from the account, you are able to enjoy many more years of tax-exempt growth. Additionally, a Roth IRA account can pass to your named beneficiaries outside of probate and you can withdraw from the account for a first time home purchase, medical expenses, and qualified education costs.”
Jordan Fandry, CFS(r), CRPC(r), Investment Associate, Manske Wealth Management
The Perfect Place For Stocks Is In A Roth IRA
“The perfect place for stocks is in a Roth IRA. The tax free nature of these accounts lends to incredible advantages down the road, especially for higher risk assets. The tax advantages of an IRA or Roth and when to use which is another question, but once the money is in the accounts, the higher risk assets should be held in Roth. Regularly as we look at asset allocation for clients of a certain risk tolerance, we want to maintain a balance, but shift stocks to the Roth and bonds to the IRA. One simple reason: taxes.
That IRA will owe taxes one day, if not through voluntary withdrawals, then definitely through Required Minimum Distributions. This is one of the biggest blind spots people have in retirement and can be devastating in the amount of taxes owed. The more your IRA account grows, the more taxes will be owed. If you can look at your portfolio, across all accounts, as holistic, then you can achieve the same returns for your risk tolerance, but dramatically improve the taxability of those accounts by letting your high-growth assets accumulate in the Roth. This has a dramatic effect on the after-tax returns of your overall portfolio; and after all, all that matters about your return is how much you keep.”
Dave Lowell, CFP, Founder, Up Your Money Game
A Roth IRA Is A Great Place To Hold Equities Whether Individual Stocks Or Equity Mutual Funds
“I believe that a Roth IRA is a great place to hold equities whether individual stocks or equity mutual funds. The advantage of holding them within a Roth IRA is that there will not be any taxes related to the assumed appreciation of the positions. The stocks or stock mutual funds will not be subject to the annual tax on dividends and capital gains, which allows the account to grow exponentially over time.
In addition, when funds are withdrawn from the account, the amount will not be subject to income tax. Though each individual's circumstance is different, it is generally advised to hold aggressive growth positions in a Roth account and the more conservative, less tax-sensitive investments in both traditional IRAs and individual brokerage accounts, if possible.”
Peter M. Ferriello, CFP(r), Senior Wealth Advisor, VP, Mollot & Hardy, Inc. Wealth Advisors
Probably, But It Depends
“It’s been 22 years since the introduction of the Roth IRA by Senator William Roth (Delaware). The potential tax benefits are attractive due to tax-free growth and withdrawals in exchange for paying income tax on deposits upfront. But is a Roth IRA the “best” place to hold stocks?
The answer: probably, but it depends.
When investing, what investors own is commonly referred to as ‘asset allocation'; where they hold it is ‘asset location’ —and where we hold assets is almost always a product of tax optimization. The tax benefits of Roth IRAs are better realized when there is higher growth in the account (due to tax-free withdrawal of investment growth). Investors would be wise to realize that length of time and investment growth potential are directly related (i.e. the more time you have to invest, the better the opportunity to pursue compounded returns). When choosing what investments to place within a Roth IRA, an investor must look at how long they can invest and whether they can tolerate the volatile price swings of an aggressive investment. Stocks have historically been volatile investments, but they’ve also rewarded the long-term, disciplined investor. If the investor has a long time to invest and they understand that price swings are normal in riskier asset classes, then a Roth IRA may be one of the best places to own stocks.
For short term investors, or those lacking the temperament to deal with market swings, something more conservative than stocks may be a better fit.”
Adam C. Harding, CFP®, Harding Investments & Planning
A Roth IRA Is The Most Flexible Savings Opportunity
“The Roth Individual Retirement Account (IRA) is by far the most popular and also the most flexible savings opportunity. Unlike most other retirement savings plans, Roth IRA deposits are tax-advantaged implying that contributions to the Roth account are made post-tax. Withdrawals are therefore not subject to tax and so is any incomes derived from their investments as long as they are qualified. This makes it an attractive retirement option for individuals looking for a tax-free and multiplicative savings plan.
But this isn’t the only reason you should save in a Roth IRA. You can use these deposits to invest in the stock markets. Others include the fact it doesn’t have a required minimum distribution (RMD) or age limit within which these funds can be withdrawn. Plus while traditional IRAs attract penalties of up to 25% on early withdrawals, Roth IRA attracts a maximum 10% penalty.
Additionally, your deposits and their earnings will pass on to your beneficiaries’ tax-free – save for the estate tax – in case of your death. The tax and penalty-free withdrawals of both the deposits and earnings will also be made available to you should you become disabled. More importantly, you should use the Roth IRA deposits to invest in the stock markets because its tax-free nature doesn’t increase your tax liability, retirement Medicare premiums, or social security tax.”
Edith Muthoni, Chief Editor, Learnbonds.com
The Role of Stocks In A Roth IRA Can Be Weighed With Several Factors In Mind
“Deciding whether or not to go with a Roth IRA over a Traditional IRA depends on the individual's need for current tax deductions, possible estate planning purposes, and most importantly, their investment returns. Unfortunately, returns are much harder to anticipate than the first two factors. Stocks can offer balance to a portfolio which may be made up of funds, real estate, and liquid assets; therefore, their role in a Roth IRA can be weighed with the following in mind.
The first thing to understand is the time value of money. By making contributions to a Roth IRA, you are forgoing any tax deductions for those contributions. In other words, you are paying the taxes up-front.
Economics teaches us that money is worth more now than it will be in the future. So why would you want to pay the taxes now instead of deferring them to the future? Sometimes, if you flip this on its head, you get an advantage so stay with me on this.
The second thing to understand when you invest stocks in a Roth IRA is what happens when you experience losses. If you invest poorly, not only are you losing the principal investment, you are also losing the tax advantages that you were hoping to enjoy in a Roth IRA. *Furthermore, if you do a Roth“conversion” and then experience losses, you are paying taxes on a larger value than you currently have. With a traditional IRA, you only get taxed on the end value of your distributions. In previous years, you could “recharacterize” or “undo” your Roth conversion before your next tax filing which mitigated some of the risk with immediate losses incurred after the conversion. However, the IRS removed this option in 2019, so once your conversion has been processed, there is no going back.
But let's consider the upside of Roth IRAs. First, when your Roth IRA investment experiences gains, it's a big win. Anything that happens inside a Roth IRA happens Tax-FREE. Not tax-deferred. Tax-FREE. That means that if you invest well, you ELIMINATE 100% of the taxable gains. Going back to the example of the time value of money above, maybe it isn’t such a bad thing to pay taxes up-front if you pick the right investments and are able to eliminate all of the “future” taxes that would have been owed under a Traditional IRA account.
The second advantage to a Roth IRA involves protection against tax rate changes. If tax rates go up in the future, Traditional IRAs are subject to these changes at the time of the distribution. However, Roth IRAs have already been taxed, so as long as the distribution rules are followed (over 59.5 age and have had the Roth IRA for at least 5 years), distributing from a Roth will be tax-free, no matter how much the rate has increased. *And the last edge you have with a Roth IRA is in e**state planning. There are no Required Minimum Distributions. With Traditional IRAs, you must begin removing money from your IRA at age 70.5. For estate planning purposes, especially for those who do not need the money in retirement, this gives you the ability to pass on a huge tax advantage to your heirs. While your beneficiaries must begin removing the money upon inheritance, the amount they are required to remove will be based on their life expectancy. So, the younger the beneficiary, the longer they have to keep the money in a tax-free status.
The higher the potential for growth, the more you can reap the potential benefits of a Roth IRA. This is where it gets tricky though; clearly, all stocks are not created equal so you will want to have good guidance on choosing your stock. And if you do not invest in stocks, what other option do you have?
It is a quietly held secret that, while stocks are the investment choice most people know about, retirement accounts like a Roth IRA can also hold other “alternative” investments, such as Real Estate, Notes, and Private Placements. These are called Self-Directed Retirement Accounts. All the same Roth IRA rules apply, but the options are now wide open to investors to include privately held stock, a piece of investment real estate, or even a note to another person. Yes, a Roth IRA can own a piece of property or an apartment building. Self-directed IRAs allow investors to choose assets they have experience in or knowledge of, and they often invest in the same type of assets with their non-retirement funds as well.
The biggest takeaway is this: if you invest the same base amount in a Roth and a traditional IRA and it grows over time, the Roth would offer the benefit that the tax is pre-paid on the investment up-front and is tax-free when the investor chooses to receive it. Whether you choose stocks or real estate will depend a great deal on your knowledge in both types of investments. As with all investing, your risk tolerance, your knowledge of the particular investment and the guidance of your Financial Advisor and/or CPA will be invaluable to determine the direction you take.”
Brandon Hall, CISP (Certified IRA Service Professional), Executive Vice President/Chief Operating Officer, Midland Trust Company
A Roth IRA can be the best place for stocks depending on individual financial goals. If investing in this retirement account interests you, factor in what these financial experts have discussed, and always do your due diligence.