Thursday, November 11, 2010

Dividend Machines, Taxes, & Roth IRA

Taxes always reduce the amount of income you take home. This applies to salary, bonuses, and yes investment income. This blog is not a discussion on the wisdom or value of taxation. This blog is to help you learn how to invest for income and income has tax implications.

If your investments are not in qualified retirement accounts but are in taxable accounts, you will pay tax on the dividend income.

Municipal bonds are the most common investment to use in taxable accounts as their income is usually tax free. Some municipal bonds like the newer Build America Bonds are not tax free but for the ordinary investor, municipal bonds are the most common non taxable income investment tool.

I have worked with some very smart and very rich people who are close to 100% invested in municipal bonds. This strategy I cannot agree with. I think everybody has to be diversified. Therefore, even these people need to consider another income investment and stock dividends are appropriate.

Dividends are taxed, at 15% today but that could change in 2011.

You always have to be concerned about taxes and that is why you may want to hold your dividend machines in a Roth IRA. Dividends, interest and for that matter capital gains in Roth IRA's are not taxed. You can have those dividends deposited into your personal checking account with no tax consequence. Or, you can allow those dividends to accumulate and when you need the money, distribute it tax free.

Dividends held in traditional IRA's are also not taxed but when you distribute that income you are taxed at ordinary income rates.

Dividend machines have a place in every income investor's portfolio, especially now with bond interest rates so low, but the most tax efficient account to hold your dividend machines is a Roth IRA.

Very Truly Yours,

TheMoneyMadam

Next week another dividend machine idea for you to consider.