Feb 7, 2010
Is It Better To Have Stock Or Taxable Bonds In A Retirement Account?
I have a tax class where one of the questions is is it better to have only stock in a retirement account or only taxable bonds? any ideas??? At this point i think the taxable bonds should go in the retirement account because the coupon interest that is received twice a year is usually taxed at ordinary income tax rates and stock dividends would be at more favorable rates if they were not part of a retirement account. am i correct on this? any help would be great. thnx.
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Neither, actually. Any gain in a retirement account accrues tax-deferred until withdrawal at which time all monies distributed are taxed as ordinary income. How the gains are characterized within the account is irrelevant.
SOME stock dividends are taxed at a lower rate but not all dividends do. Qualified dividends are taxed at the more favorable long-term CG rate but ordinary dividends are taxed as ordinary income. There’s no guarantee that any dividend will be treated as qualified dividends up front, and a company’s dividend payment history is no guarantee of what they will do in the future.
Furhtermore, the principal reason that you’d hold stocks is for capital gains, not dividends. Some companies rarely pay dividends. Even though long term CG rates are lower than the rate on bond interest, the overall growth potential of stocks over time is considerably greater than with bonds which offsets any differences in tax in the long term.
Most financial planners recommend a mix of investments in a retirement account, including stocks and bonds. Within those classifications you should have a further mix of higher yield, higher risk investments as well as lower yield, lower risk investments. As you age you should reallocate your investments towards lower risk in order to preserve capital. While you are younger you can tolerate higher risk in exchange for higher yield since time is on your side and will reduce the overall risk.
The one thing that you do NOT want in a tax-deferred account is tax-free or tax-deferred investments such as municipal bonds or annuities. That would convert tax free or deferred gain into taxed, a foolish choice.