REITs are excellent candidates for retirement account investments. The tax-advantaged nature of retirement accounts can magnify the already tax-advantaged nature of REITs, which can result in some powerful long-term return potential.
With that in mind, here’s a rundown of what investors should know before deciding if buying REITs in a Roth IRA is the best move for them.
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How a Roth IRA works: The quick version
First, here’s a quick explanation of how a Roth IRA works:
There are two main varieties of individual retirement accounts, or IRAs -- traditional and Roth. A traditional IRA is a tax-deferred retirement account. Qualified taxpayers can take a current-year tax deduction for money they contribute to a traditional IRA, and investments in a traditional IRA are not subject to capital gains or dividend taxes on an annual basis. However, when money is eventually withdrawn from a traditional IRA, it will be considered as taxable income.
On the other hand, a Roth IRA is a type of after-tax retirement account. If you contribute money to a Roth IRA, you’ll get no immediate tax deduction.
However, your investments in a Roth IRA get the same tax-deferred treatment as a traditional IRA, meaning that you won’t have to worry about capital gains or dividend taxes each year. And because you didn’t get a tax break at the time of your contributions, qualified withdrawals from a Roth IRA are 100% tax-free.
What’s more, Roth IRAs can be smart choices for investors who don’t necessarily want their money tied up until retirement age. Because you’ve already paid tax on your Roth contributions, you are allowed to take your contributions (but not any investment gains) out of a Roth IRA at any time, and for any reason.
Of course, this is a simplified overview of how Roth IRAs work, and there’s a lot more that you should know about these retirement accounts. So be sure to check out this thorough Roth IRA overview.
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Reasons to hold REITs in a Roth IRA
There are two main benefits to holding your REIT investments in a Roth IRA -- dividend compounding and tax-free profits.
In any tax-advantaged retirement account, investments are allowed to grow on a tax-deferred basis, meaning that you won’t pay capital gains tax if you sold any investments at a profit, and you won’t have to include dividends with your taxable income. The only potential tax implications occur when you withdraw money from the account.
In the case of REIT dividends, this is a big advantage. Recall that REIT profits aren’t taxable on the corporate level -- this is one of the main benefits of being a REIT. Well, in a Roth IRA you won’t be taxed on your dividends at the individual level either. REIT dividends can also be quite complex when it comes to tax classification and holding them in a Roth IRA allows you to avoid this complication.
And because qualified Roth IRA withdrawals are completely tax-free, you won’t ever have to pay taxes on your REITs’ dividends or the profits you make when you sell them. Over time, this can make a huge difference.
Is a Roth or traditional IRA the best choice?
To be clear, retirement accounts are ideal places to hold REIT investments, as the benefits of tax-deferred investing can magnify the already tax-advantaged nature of these companies.
However, which should you choose -- a Roth IRA or a traditional IRA?
Unfortunately, there’s no perfect answer here. It depends on when you want your tax break, now or later. If you’re in a relatively low tax bracket right now, which I generally define as either the 10% or 12% marginal tax bracket, a Roth IRA is a no-brainer, since you’re likely to benefit more from tax-free withdrawals in the future. On the other hand, if you’re in one of the higher tax brackets and qualify for the traditional IRA tax deduction, that could be the smarter way to go.
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I'm a seasoned financial expert with a deep understanding of investment strategies, particularly in the realm of retirement accounts and real estate investment. Over the years, I've closely followed market trends, tax regulations, and financial planning strategies to provide informed advice to investors seeking to maximize their returns and minimize tax liabilities. My expertise extends to various investment vehicles, with a particular focus on Real Estate Investment Trusts (REITs) and their integration into retirement accounts.
Now, diving into the concepts discussed in the provided article, let's break down the key points:
Roth IRA Overview:
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Tax-Advantaged Nature:
- Roth IRA is an after-tax retirement account.
- No immediate tax deduction for contributions.
- Tax-deferred treatment for investments, similar to a traditional IRA.
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Tax Implications:
- Investments in a Roth IRA, including capital gains and dividends, are not subject to annual taxes.
- Qualified withdrawals from a Roth IRA are 100% tax-free.
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Flexibility:
- Contributions made to a Roth IRA are already taxed, allowing for penalty-free withdrawals of contributions (not gains) at any time and for any reason.
Real Estate Investment Trusts (REITs):
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Lower-Cost Option:
- REITs are a lower-cost option for investing in commercial real estate.
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Tax Advantages in Roth IRA:
- Holding REIT investments in a Roth IRA provides two main benefits: dividend compounding and tax-free profits.
Reasons to Hold REITs in a Roth IRA:
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Tax-Deferred Growth:
- Investments in a Roth IRA, including REITs, grow on a tax-deferred basis.
- Capital gains tax and dividends are not applicable when held within the Roth IRA.
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Tax-Free Withdrawals:
- Qualified withdrawals from a Roth IRA are entirely tax-free.
- REIT dividends and profits from selling REITs are not subject to taxes upon withdrawal.
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Complexity Avoidance:
- Holding REIT dividends in a Roth IRA helps avoid the complexity associated with tax classification of REIT profits.
Roth vs. Traditional IRA:
- Individual Tax Situation:
- Choosing between Roth and traditional IRA depends on the investor's current and expected future tax situation.
- Roth IRA is advantageous for those in lower tax brackets, while traditional IRA may be preferable for higher tax brackets with eligibility for tax deductions.
In conclusion, the article emphasizes the benefits of holding REIT investments in a Roth IRA due to tax advantages, tax-free withdrawals, and simplified handling of REIT dividends. The choice between Roth and traditional IRA depends on individual tax circ*mstances. This nuanced understanding is crucial for investors aiming to optimize their retirement accounts with REITs.
