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How to Really Rock Your Roth

One of the great joys of writing about personal finance is to read and write about the successes of common investors -- Fools like Rob Ketterer, a government consultant who began with $500 in a basket of stocks including ExxonMobil and Cisco Systems (Nasdaq: CSCO  ) , which went on to post dynamic returns over long periods of time, and who today owns a house and three rental properties.

Rob's story is great, but it's not unique. One Foolish reader, Tim S., reported that his grandfather invested $350 in Pfizer in 1960. By 2006, thanks to the awesome power of dividend reinvesting, he owned 9,100 Pfizer shares paying $10,500 annually in dividends. And even with Pfizer's dividend cut earlier this year, he'd still be earning more than $6,000 annually -- more than a 1,700% yield on his original investment.

But you can one-up Tim's granddad. He began investing long before the Roth IRA was available. You, on the other hand, are young, good-looking, and in your prime earning years.

If you're married and your total adjusted gross income (AGI) is less than $166,000, you can contribute the full $5,000 to a Roth for the 2009 tax year, up until April 15, 2010. So can your single friend Mike, who, at $72,000 in AGI, is well below the $105,000 income limit for a full Roth contribution. Wonderful!

Be a rich turtle
But don't get complacent. A Roth alone won't make you or Mike rich. Other investment vehicles, such as a traditional IRA, will allow you to invest in stocks just as a Roth will. What you both need to do is maximize the earning potential of your investments.

Which brings us back to Tim's story. Today, dividend distributions, even when reinvested, are typically taxed at a 15% maximum rate. In contrast, though, any money you take out of a traditional IRA, even if it came from dividends, gets taxed at ordinary rates up to 35%. But not so with a Roth. Were you to build and regularly contribute to a portfolio of large stocks that have a history of increasing dividends, you could do as well as Tim's granddad did, except that you'd be collecting your dividends tax-free.

Put differently: Imagine collecting a tax-free pension. That's what a Roth can help you and Mike do. Because by reinvesting those tax-free, you'll own more and more shares of stock and receive more and more each year in dividends.

They might be dividend giants
The key to making this happen is to fill your Roth IRA with companies that have shown a willingness to raise their dividends year in and year out. With that in mind, here's a list of large caps that yield at least 3% and have increased their dividends by an average of 15% or more annually over the past five years:



5-Year Average Annual Dividend Growth

Intel (Nasdaq: INTC  )



Microchip Technology (Nasdaq: MCHP  )



Lockheed Martin (NYSE: LMT  )



Linear Technology (Nasdaq: LLTC  )



Centerpoint Energy (NYSE: CNP  )



Hudson City Bancorp (Nasdaq: HCBK  )



Source: Capital IQ, a division of Standard & Poor's.

Bear in mind that this isn't a comprehensive list. Nor is it infallible. Be sure to do your own due diligence before investing in any of these stocks.

Dividend reinvesting is a wonderful way to rock your Roth and get rich in the process. But it isn't the only path. Want more ideas? Learn more about IRAs and investing with these great resources:

This article, written by Tim Beyers, was originally published on March 29, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Linear Technology is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended buying calls on Intel, which is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy plays a mean air guitar.

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