Is it Better to Have Stocks Or Bonds in an IRA?
Positioning stocks and bonds within your portfolio plays a pivotal role in its long-term performance. Common wisdom states that equity holdings should be kept taxable to take advantage of lower ordinary income tax rates while bonds should be placed within an IRA to avoid taxes on future gains.
Investors must carefully consider the tax ramifications when investing in an IRA. Earnings typically grow tax-deferred until withdrawal in retirement.1
Investors in alternative assets face unique challenges. Unlike stocks and bonds, most alternative assets do not have established market values and thus can be difficult to sell quickly or reliably. Furthermore, these assets often carry high fees that make selling impossible as well as being vulnerable to fraud.
As part of its reporting requirements, the IRS mandates all sales of alternative assets be reported. Investors should seek professional advice before investing in an IRA account to make sure they follow all complex IRS rules and take full advantage of any tax advantages it might provide – for instance Treasury Inflation-Protected Securities (TIPS) are often popular investments because their principal value rises with inflation; this makes them different from traditional bond funds which must pay regular interest income taxes in taxable accounts.
Stocks, mutual funds and exchange-traded funds (ETFs) are ideal investments to place into an IRA because their tax-deferred growth allows the IRS no access until withdrawal time when your earnings can be used for living expenses.
Bonds or bond funds, typically held in taxable investment accounts due to their steady income streams that are taxed at regular income rates at both federal and sometimes state levels, can also be held within an IRA because their interest is tax-exempt both at federal and often state levels as well.
If you don’t have the time, expertise or desire to manage your IRA investments yourself, a target date or asset allocation fund could be an appropriate alternative. Fidelity offers both of these funds at reasonable costs.
IRAs offer tax-deferred growth, and investors often aim to maximize their returns through active trading in an IRA. But active trading can be costly and ineffective; for the best long-term results it’s better to use low-cost index funds with a buy-and-hold strategy and invest passively with this approach – taking your time in holding investments over the years can pay dividends!
Assuming an investor has an extended time horizon, placing stocks in an IRA can provide preferential long-term capital gains tax rates and deferring income taxes until withdrawals occur. Furthermore, placing bonds within an IRA may help mitigate near-term taxes by deferring income taxes until withdrawals take place.
Investors may wish to open both types of accounts in order to invest in municipal bonds, which are exempt from both federal and state taxes. An IRA should be used for bonds that produce short-term capital gains while stock funds that produce high turnover should be held in a taxable account due to early withdrawal penalties if they fall below a certain threshold in value.
Your investment time horizon refers to how long you intend for your investments to remain invested before they become necessary for you, such as buying a new car or paying off a home loan. It could also refer to saving for retirement.
Longer time frames increase the impact of tax rates, so tax-deferred growth for stocks (Scenario 1) will outstrip its rival, such as holding similar assets in taxable accounts without such tax advantages (Scenario 2).
But it is important to keep in mind that withdrawing funds before age 5912 may incur steep penalties; thus, it’s wiser to plan accordingly.