DG Investing in a Taxable or Deferred Account?

05 Feb 2014 15:23

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I occasionally get asked if using a tax deferred account (such as an IRA) is better than a taxable account for dividend growth investing and my answer is always the same; it depends.

There is no absolute right answer and much depends on your goals and where you are in life. If your goal is to create an income flow during retirement then a Roth IRA or Roth 401K is your best solution.

If you are saving to build an emergency fund then a taxable account is your best solution as you can easily access your income stream without paying early withdrawal penalties. But this all depends on your age and how far along you are towards your goal. The closer you are to your goal or nearing retirement age (within 10 years) it would make sense to start placing all or some of your future investments into a tax deferred account while you still qualify. The ability to grow dividends at an even faster rate would be yet another tool to help combat inflation during your retirement years.

Besides growing your earnings in a tax free or deferred IRA or 401K there is an additional benefit that may be realized that investors should not overlook. Some U.S. States have a classification of being “tax friendly”. Tax friendly states, such as Pennsylvania, do not tax distributions from 401(k)s, IRAs, deferred-compensation plans or other retirement accounts. If you think a Roth account solves this think again. A Roth may help with federal taxes but States are under no obligation so “tax un-friendly” states such as Connecticut are not shy about taxing Roth distributions. If you are fortunate enough to live in or plan to move to a tax friendly State then consider having some of your investments in a tax deferred account.

Not sure if your state is tax friendly? Check out this neat tool from Kiplinger’s that summarizes all 50 States. Kiplinger's State by State Tax Guide Link

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