Saving for retirement using an IRA is a great way to save on taxes and speed up your journey toward your financial goals. But not all investments will make the most of the tax advantages offered by an IRA. Here are three investments you’re best off keeping in a regular brokerage account.
1. Municipal bonds
Municipal bonds, or “munis”, are debt securities issued by municipalities. The advantage of investing in munis is that interest payments are exempt from federal income tax. Additionally, if you buy bonds from municipalities in your home state, they are usually also exempt from state income tax.
People also read…
Since municipal interest payments are already tax-exempt, you don’t gain much benefit from holding them in an IRA. Munis generally pay lower interest rates because of the tax benefits they offer, so you’re better off buying another type of bond for your IRA with less tax benefits than munis and lower interest payments. higher interest.
If you want to invest in municipal bonds, you must hold them in a taxable account. You should also do a quick analysis to find out if your tax savings are enough to make the interest rate cut worth it.
2. Master Limited Partnerships
Master limited partnerships, or MLPs, are another investment with built-in tax advantages. Since they are structured as a partnership, cash flow and profits are distributed directly to the owners, called unitholders, so they pay no corporate taxes.
There are also tax benefits for unitholders. Since most MLPs can claim substantial deductions on their taxes, actual profits are far less than cash flow. As a result, unitholders receive significant tax-deferred cash flow each quarter.
Since an MLP already provides tax-deferred benefits, there’s no reason to use an IRA to defer taxes on them if you could otherwise buy shares in a taxable brokerage account. Additionally, by holding MLP units in a taxable account, your heirs may be able to take advantage of the increased costs upon your death. This would eliminate much of the tax liability associated with investing in MLPs.
3. Foreign dividend payers
Foreign stocks can be a great way to diversify your retirement savings, but you may not get all the tax benefits if you hold foreign stocks with large dividends in your IRA.
Although domestic dividends are not taxed in an IRA, you will still see taxes waived on dividends paid by most foreign corporations. These are taxes paid to the home government of the company.
The United States has a law that allows these taxes to be reclaimed: the foreign tax credit. This way you do not pay taxes in the United States and in the foreign country. But you can’t claim that credit if you hold those dividend payers in an IRA. Thus, you end up receiving no benefit on the taxation of dividends by holding them in an IRA.
The United States has entered into treaties with foreign governments to exempt stocks held in retirement accounts from foreign taxes. For example, stocks of Canadian corporations will not withhold tax on their dividend payments in an IRA.
What should you invest in?
While you can still buy muni bonds, MLPs, and foreign dividend payers in your IRA, you simply won’t get the most of the tax benefits the retirement account offers. To maximize the usefulness of an IRA, you’ll want to buy investments that don’t have special tax advantages.
Even better, you might find an opportunity to hold investments that would incur a significant tax burden if you held them in a standard brokerage account. For example, REITs and high-yield bonds can produce large tax bills each year and can produce better after-tax returns in your IRA.
It pays to learn the basics of how your investments are taxed and the benefits of holding them inside an IRA. This will allow you to make more informed decisions about what you invest in and where you hold those investments to maximize your portfolio balance.
The $18,984 Social Security premium that most retirees completely overlook
If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help boost your retirement income. For example: an easy trick could earn you up to $18,984 more…every year! Once you learn how to maximize your Social Security benefits, we believe you can retire confidently with the peace of mind we all seek. Just click here to find out how to learn more about these strategies.
The Motley Fool has a disclosure policy.