5 Investment Options for a Roth IRA

Evan Crosby

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The investments that can benefit the most from a tax-sheltered Roth IRA

Since you have already paid taxes on the money that you contribute to a Roth IRA, your investments will grow tax-free as long as you wait to withdraw them until you are eligible. Therefore, the best investment options for a Roth IRA are those that tend to generate significant taxable income that you wish to shelter from taxes:

  • Income and growth stocks
  • Dividends
  • Interest from high-yield corporate bonds
  • Capital gains
  • Real Estate Investment Trusts (REITs)

Since all of those investments have the potential to generate substantial returns, you can end up getting hit with a huge tax bill - especially if you hold them in a traditional brokerage account. Here are five investments that can benefit the most from holding them in a a tax-sheltered Roth IRA.

1. Corporate Bonds

When you buy bonds that companies issue to raise capital, you will (taxable) interest income until the bonds reach maturity. Since corporate bonds tend to be riskier than government bonds, they often pay significantly higher interest. Therefore, if you invest in high-yield corporate bonds, a Roth IRA can provide a good tax-shelter for your interest income.

2. Income Stocks

Income stocks - also known as "blue chips" - tend to be large, well-established companies that are no longer in their growth phase. Instead, they generate a consistent, solid income that they largely return to shareholders in the form of dividends. Since dividend income is taxable, it can make good financial sense to hold income stocks in a tax shelter like a Roth IRA.

3. Growth StocksUnlike income stocks, growth stocks tend to be small- and mid-cap companies that are still in their growth phase. Therefore, instead of generating significant (or any) dividends, they tend to create larger capital gains, which are subject to capital gains taxes. Therefore, a Roth IRA can make a great tax shelter for growth stocks.

4. Mutual Funds

Mutual funds are one of the most popular investment options for investors since they offer investors professional management and diversification. Mutual funds, especially actively managed funds, often generate significant capital gains and dividend income to investors at the end of each year - subjecting them to capital gains and dividend taxes. However, by investing in mutual funds through a tax-sheltered Roth IRA, you won't be subject to dividend and capital gains taxes.

5. REITs

Buying shares of a REIT is one of two ways to invest in real estate. REITs typically hold a wide variety of properties - ranging from rentals to cellular towers. Furthermore, they often pay high dividend yields, which can subject investors to significant dividend taxes. That's why REITs make another good investment option for Roth IRAs.

In short, if you are eligible to open and invest in a Roth IRA, it can provide you with a great tax-shelter for investments that tend to generate higher taxable income and capital gains. Therefore, you have the potential to build substantial tax-free wealth that you can even pass on tax-free to your heirs.

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