3 Great Investments to Include in Your Traditional IRA
As you put together your retirement portfolio, you might have some assets spread across a 401(k), a taxable account, and an IRA. The types of accounts you use to invest in each type of asset can have a meaningful impact on your after-tax returns.
If you use a traditional IRA in your retirement planning, you should consider prioritizing the following three types of investments in that account.
REITs, or real estate investment trusts, pay out 90% of their taxable income as dividends to shareholders. Because of their business structure, they don’t have to pay corporate tax on those earnings. Unfortunately, that means shareholders have to pay regular income tax on dividends from REITs instead of the lower qualified dividend tax rate.
If you hold your REIT shares in an IRA, though, you won’t owe any taxes on those dividends. Of course, you’ll eventually pay income tax when you take distributions from your IRA, but you should be able to pay a lower tax rate on distributions in retirement than you would if you paid income tax on the dividends while you were working.
You can get the same benefits in a Roth account, but the Roth is best-suited for assets with the highest expected return. REITs generally offer middle-of-the-road expected returns. If you’re investing in a REIT that you think has high total-return potential, consider a Roth instead.
2. Corporate bonds
Corporate bonds suffer from the same tax problem as REITs. The interest payments on those bonds are taxed at your ordinary income tax rate if you hold them in a taxable account. You can shield yourself from that tax burden by holding them in a tax-protected account like an IRA.
Again, the idea is that your income tax rate will be lower in retirement than your marginal tax rate is during your working years. Furthermore, the total return expectation on bonds is typically lower than that of other asset classes like stocks, so you may not want to prioritize them in a Roth account. That said, junk bonds (so known because of their higher risk of default) may produce a high total return, and investors may consider holding them in a Roth account as well.
3. Complements to your 401(k)
While a 401(k) is a great retirement account with many advantages, one drawback to most 401(k) plans is a limited number of investment choices. That can leave some holes in your portfolio, and you can probably fill them in by using an IRA. IRAs provide investors with much more freedom to choose their own investments.
One example of an area where your 401(k) may be lacking is in inflation-protected assets, like TIPS. In fact, an IRA is a great place for TIPS because the adjustments on TIPS are taxed as income every year, whereas an IRA will allow you to defer those adjustments.
Another situation may be that the fund offerings in your 401(k) for a certain asset class are simply much more expensive than others. If you can find a fund with a low expense ratio, you can buy it in your IRA and put more of the money in your 401(k) toward less expensive options.
Taking the time to consider where you invest in certain assets based on the options you have and the tax treatment of each one will help you produce better after-tax returns without taking on any additional risk.
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