Friday, October 28, 2011

Roth IRA’s for Dividend Investors

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 IRA’s are those made at least 5 years after the taxpayer’s first contribution to a Roth IRA and made:

1) After the taxpayer become 59.5 years old
2) To a beneficiary after the death of the taxpayer
3) Because the taxpayer becomes disabled
4) 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 IRA’s 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. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. Yield: 4.30% (analysis)

Johnson & Johnson (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 (PG) provides consumer packaged goods in the United States and internationally. Yield: 3.40% (analysis)

PepsiCo, Inc. (PEP) engages in the manufacture, marketing, and sale of foods, snacks, and carbonated and non-carbonated beverages worldwide. Yield: 3.20% (analysis)

Kinder Morgan, Inc.(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% (analysis)

Relevant Articles:

- Kinder Morgan Partners – One Company three ways to invest
- Philip Morris International (PM) Dividend Stock Analysis

This article is part of 2012 Roth IRA movement.


  1. How do you take the emotion out of investing? I have been doing dollar cost averaging (monthly) for the last few years in my Roth IRA. That has made it almost automatic where I don't really get too emotionally involved. But now I want to get more involved in my investing.

    I have been following your blog (and reading others) on dividend investing. I currently have some extra money I want to invest outside of my Roth IRA and 401k. The only problem is, I cannot "pull the trigger" and make the purchases. My entry criteria is similar to yours.

    How do you (or anyone else that reads this comment) take that step and "pull the trigger"?


  2. Good post, for the very reasons you stated my Roth IRA contributions will go to a new account that I will populate with dividend growth stocks.

    Anon-You are almost there with having entry criteria. As long as a stock meets my entry criteria and is trading at a discount it goes on my buy list. At that point I look at what stocks are on the buy list, how big the discounts are, and which would be the best one for my portfolio at that time. Select the optimal one and make your purchase.

  3. How much time do you have on your investments? Is this something you are doing for 10-15 years down the road? Or shorter term?

    I personally am investing for 20+ years down the road, so once I have the cash I just pull the trigger now.

    I probably could get another 5% on a dip, but at the same time over a long enough horizon I am not concerned over % here of there.

    I certainly would really enjoy hearing how those with a shorter time frame view.


  4. Somewhere along the line I got the idea that Kinder Morgan was not appropriate (or even legal?) for tax deferred accounts. Did I make that up?


  5. Following up on Anonymous #2's comments, I know I have asked this before, but I would enjoy hearing anyone else's comments on how they balance waiting for optimal price v. missing out on time of divdend growth and compounding.


  6. Great minds think alike. We hold all of those positions in our Roth IRA Fund.

    Have you considered taking positions in the like of NLY?

  7. @Randy....You may be confusing KMI with KMP which cannot be held in a Roth.

  8. Dividends For The Long Run - how exactly do you calculate the discount? by discount do you just mean lower PE than average?

  9. I have been looking into exchanging some of our mutual fund assets (which are in IRAs) into dividend growth stocks, within the same IRAs. What is the advantage you find to having your assets in taxable brokerage accounts? It seems to me that having the stocks reinvested, within the IRA, until the funds are needed for income or a mandatory distribution would be the best scenario. Please comment--I read this blog almost daily and value your opinion.
    Thank you in advance.

  10. Great starting point for People considering Roth IRA's: My wife and I have maxed out since 2008 and done very well. With 15 years until I retire and 25 till my wife is 65 we expect this to be a big part of our retirement.

    One small "con" point: If you lose money in your traditional investment accounts you have the ability to "write off losses" from your taxes. The same is true by default of a traditional IRA in that you don't' have to pay taxes on the loss as you pay taxes on what you take out of the account (so less to take out means you don't pay tax on it). If you lose money in a Roth IRA you still have the original tax burden of the value you put into it. However, since most peoples time horizon for an IRA is decades rather than years, this is a pretty small concern.

    New contribution limits: $5500 and $6500 for +50's

    Also, it is worth noting that there WAS a tax advantage for people inheriting (spouse and your kids) Roth IRA's, but I think that may be under threat.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

Popular Posts