Buying dividend investments in an IRA can be a good strategy to generate tax-advantaged income and growth for the IRA account. Choices for this strategy include regular stocks that pay attractive dividends and real estate investment trust -- REIT -- shares, which typically pay dividends at higher yields than most stocks. Understanding how each type of investment works will help you pick the best choices for your IRA.
Most of the stocks traded on the stock exchange are shares of corporations. A corporation can elect to pay out a portion of earnings to shareholders in the form of dividends. Some companies pay out a high portion of income as dividends and tend to have a higher dividend yield. Other companies have a history of steadily increasing dividends, providing a long-term, growing stream of income to investors. Investors looking at dividend paying stocks must balance current yield with the potential growth of the dividend payout.
A real estate investment trust -- REIT -- is a company which owns real estate properties or real estate loans. The shares of an REIT trade on the stock market in the same manner as corporate shares. An REIT qualifies under a special section of the tax rules to pay no income taxes as long as the company pays out at least 90 percent of the annual earned income as dividends to shareholders. The high required payout of profits turns many REIT stocks into high-yield investments. Also, many REIT stocks have multiple-year records of steady or increasing dividend payments.
Dividends received from regular stocks and REITs are taxable income. The dividends from regular corporations are usually classified as qualified dividends, and the maximum tax rate is 15 percent. REIT dividends are taxed at the investor's regular marginal income tax rate, which could be up to the current highest tax bracket of 35 percent. In a taxable account, REIT dividends are taxed more than regular stock dividends, so in an IRA the tax savings on REIT dividends will be greater than the tax savings on regular stock dividends.
If you plan to buy income stocks in both a regular, taxable brokerage account and a tax-advantaged IRA account, it would be better to buy regular, dividend paying common stocks in the taxable account and buy REITs in the IRA account. Earning REIT dividends in an IRA saves more in taxes than earning the same amount of stock dividends. Remember that REIT stocks cover only the real estate sector of the market. If you do not own other stocks outside of your IRA, buy some regular dividend paying stocks to diversify the account.