Is it Better to Have Stocks Or Bonds in an IRA?
An Individual Retirement Account, or IRA, allows you to save for retirement with stocks, bonds or mutual funds.
Many investors hold the view that stocks should be held in a taxable brokerage account and taxed according to ordinary income rates upon liquidation, while bonds should be stored within an IRA to take advantage of preferential long-term capital gains taxes.
Taxes
Investors with long-term investment horizons tend to benefit more from holding more stocks in their IRAs as this allows for tax deferred growth over a longer time span.
Bond placement may be even more critical for investors with shorter investment horizons, given their taxed as ordinary income rather than preferential capital gains rates and thus needing extra protection from taxes than stocks.
Taxable municipal and corporate bonds typically incur an extra 15% foreign withholding tax when sold outside an IRA, further increasing your overall taxes owed when selling outside one. As a result, they’re best suited for taxable accounts rather than IRAs – however their yields tend to outpace that of stocks so the overall returns tend to remain similar.
Diversification
Typically, investors should store stocks in their IRA and bonds in taxable accounts; however, the traditional asset location rule makes a major assumption: bonds with high taxed ordinary income require greater protection from taxation than equity assets with only long-term capital gains as taxation.
This assumption is false for almost all investors, particularly those with very low portfolio turnover. The ongoing “tax drag” that accumulates with compounding value of stocks far outweighs taxation of long-term capital gains upon liquidation.
TIPS (inflation-adjusted bond funds), are also best housed within an IRA as they offer increased principal increases to keep up with inflation (not possible in taxable accounts). Furthermore, most TIPS funds offer significantly lower expense ratios through IRAs than through 401(k) plans.
Returns
While IRA accounts offer many advantages, there are certain limitations. You are limited to contributing up to the annual maximum contribution limit and any money withdrawn before reaching retirement age will incur taxes.
With a brokerage account, however, you can invest in stocks and bonds as well as exchange-traded funds (ETFs), mutual funds and more – you may even trade on margin, increasing returns.
Financial advisors advise investors to carefully select their IRA investments in order to maximize long-term return potential. When making this choice, investors should keep in mind their 401(k) quality, financial goals and risk tolerance when making this choice.
As an example, it may be wise to store investments that generate taxable income in traditional or Roth IRA accounts, while high-growth investments may work best within a brokerage account. Investors should avoid investing in collectibles or real estate since these will likely be treated by the IRS as distributions in their year of acquisition.
Fees
Investment fees associated with an IRA account should not be overlooked, although typically their costs tend to be lower than other savings products such as certificates of deposit.
Consideration should be given to expense ratio, which includes management fees and expenses charged by mutual funds or ETFs. You should search for low-cost funds that offer adequate diversification.
Betterment offers cost-effective IRA solutions at an extremely reasonable rate, such as its 0.25 percent management fee and fully diversified portfolio that invests across hundreds of companies. Furthermore, premium accounts allow you to take advantage of tax loss harvesting and access human advisors as well as provide access to traditional, Roth, rollover and SEP IRA accounts that allow investing in alternative assets like real estate, precious metals or private equity investments.
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