Investing can be a great way to grow one’s wealth where time and effort does not correlate to income like with a typical 9 to 5 job. It is great to open your brokerage account, only to be greeted with green numbers (making money). There are different types of brokerages accounts such as regular individual taxable accounts and tax advantaged accounts. The regular brokerage accounts have no tax advantages where money deposited are taxed and gains when realized are also taxed. These taxes, as with an other taxes, eat into profit. Is there a way to grow your investments tax free? Enter IRAs.
What are IRAs?
IRAs stand for Individual Retirement Account. These accounts are taxed advantaged, either tax deferred or tax preferred. Tax deferred means pushing tax costs to a later date, usually when you withdraw money from the account, and tax preferred, where tax costs are taken when depositing money and tax free when withdrawing. There are two types of IRAs: traditional and ROTH. The traditional IRA is the tax deferred; the ROTH IRA is the tax preferred. People typically invest in a ROTH IRA if they believe their current tax bracket will be lower than in the future and will invest in a traditional IRA if their future tax bracket will be lower. I will focus more on the ROTH as I have plenty more experience with it as compared to the traditional IRA.
My Take on the ROTH IRAs
IRAs are great ways to invest money without taking the hits on taxes either before or after. I personally have a ROTH IRA where the tax hit is taken upfront and ALL gains are realized tax free. I like to take advantage of this with dividend paying stocks where dividend payouts, which are usually paid on a quarterly basis, can grow untaxed. This adds to the magic of compound interest. There are different types of dividend paying categories based on the amount of time they have consecutively increased their payout: dividend aristocrats and dividend kings. These companies are great because they tend to be more established, and you can rely on their payout. Investing in growth stocks here are a waste of tax benefits since taxes only come into play when realizing your gains. However, if you see yourself “day trading” or anything close to it, you can take advantage of the short term and long term gains here. In addition, these accounts are great for holding ETFs which are baskets of stocks within certain sectors that can be beneficial to supercharge your portfolio. For example, rather than trying to invest in the right clean energy stock, I buy a clean energy ETF to have exposure to the overall sector.
Hopefully this has helped with sorting out the different uses of different types of investing accounts for you. If you would like to get started investing within retirement accounts, or just want free stocks, check out the referral links below. But until next time…
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Checking out, Kenny