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Ever since you started investing, you've heard that whenever you can, you should avoid paying taxes. Tax-favored accounts like IRAs are a great way to keep the tax man at bay for decades. But with some stocks, the IRS will have the last laugh if you put them in your retirement account.

Everyone's favorite tax shelter
In general, IRAs are amazing tools to help you save for retirement. With a traditional IRA, you get to contribute pre-tax money, giving you an immediate tax break. If investments inside your IRA pay out income, whether it comes from dividends on stocks or interest payments on bonds or bank accounts, then you don't have to pay tax on that income right away. Similarly, if you sell investments inside your IRA at a gain, you don't have to pay capital gains tax on the profits. That's the benefit of tax deferral.

Eventually, though, you have to pay the piper. With traditional IRAs, in exchange for the tax deduction you got when you first contributed to your retirement account, you have to pay taxes when you withdraw your money from your IRA. That only seems fair; after all, you didn't have to worry about taxes throughout your career. What's not fair, though, is the rate of tax you have to pay.

How IRAs can hurt you
The downside of traditional IRAs is that all the money you withdraw from your account is treated as ordinary income for tax purposes. Right now, that means you'll pay up to 35% of the amount you take out of your traditional IRAs to Uncle Sam. Next year, the rate could be even higher, if Congress doesn't extend current tax rates beyond the end of 2010.

Compare that result to the amount of tax you would have had to pay if you'd kept your investments in a taxable account. You would have paid tax on investment income each year as you received it, at whatever rate applied to that particular type of income. But most importantly, if you'd held your investments for a long time and built up a large capital gain, you would qualify for favorable long-term capital gains rates, which are currently set at a maximum of 15%.

Put another way, by not using an IRA for those highly appreciated assets, you might pay less than half the taxes you'd have to pay if you kept those investments inside a traditional IRA.

The best stocks to keep taxable
The investments that get hurt the most inside a traditional IRA are low- or no-dividend stocks. They don't generate much income, so the tax deferral an IRA provides isn't worth much. Nearly all their profit potential comes from capital gains that would be eligible for lower tax rates outside a retirement account.

To find some of the best stocks to hold outside your IRA, I turned to our Motley Fool CAPS community. I searched for highly rated stocks with dividend yields of 1% or less in order to minimize the year-to-year tax burden of keeping them in a taxable account. I also looked for attractive valuations that would make it more likely for stock prices to appreciate over the long haul, as well as a history of at least modest revenue growth. Here are some of the stocks I found:


CAPS Rating 
(out of 5)

P/E Ratio


3-Year Avg. 
Revenue Growth

Petroleo Brasileiro (NYSE: PBR  ) ***** 8.6 0.4% 6.8%
Hewlett-Packard (NYSE: HPQ  ) **** 11.3 0.8% 5.1%
Gilead Sciences (Nasdaq: GILD  ) ***** 10.9 None 23.2%
Teck Resources (NYSE: TCK  ) **** 12.2 0.9% 7.7%
Transocean (NYSE: RIG  ) ***** 7.3 None 25.1%
National Oilwell Varco (NYSE: NOV  ) ***** 12.1 0.9% 11.1%
Cameco (NYSE: CCJ  ) ***** 10.1 1% 8.2%

Source: Motley Fool CAPS.

Each of these stocks has promising prospects for growth, especially as interest around the world focuses increasingly on commodities. Technology is always a prime source for growth candidates, and health care has demographics on its side.

Yet even if things turn badly, keeping these stocks outside an IRA also lets you benefit. Each of these stocks has at least some chance of a significant loss. Transocean is at risk from the BP oil spill, and it, along with National Oilwell Varco and Petrobras, are highly exposed to the changing fortunes of the energy industry. Similarly, Teck Resources and Cameco have benefited greatly from the commodities boom, but they've seen reversals of fortune in past busts and could see them again. Even HP and Gilead aren't invulnerable to the whims of changing economic conditions, with HP having to deal with a new CEO and Gilead facing problems in its drug pipeline. If any of these stocks produces losses, keeping them outside an IRA lets you harvest those losses for immediate tax benefits.

Stay smart
IRAs are useful tools, but you have to know how to use them. By keeping the right investments outside your IRA, you'll end up with more and give Uncle Sam less over the course of your lifetime.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger gets while the getting's good. National Oilwell Varco is a Motley Fool Stock Advisor pick. Petroleo Brasileiro is a Motley Fool Income Investor selection. The Fool owns shares of and has written covered calls on Cameco. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy will never tell you to get out.

Read/Post Comments (11) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 11, 2010, at 6:27 PM, kbeck02 wrote:

    My tax guy keeps telling me to NOT roll over my IRA to a ROTH because I would have to pay taxes on all of the money I roll over. This makes sense, however, in the long run does it really? I am retired and living off of what is left of my hard earned savings. Seems to me I might be better off NOT paying taxes over the next 20, or so years. That is about as much time I have left on the planet.

    Any advice on this?

    Wish ROTHs had been around when I was working. My employer only matched my contribution for about the last 5 years of my employment (I wasn't and "upper level" employee!). All of the rest of the money I saved (since 1977) in IRAs and the 403b was all my own.

  • Report this Comment On October 11, 2010, at 7:32 PM, gabbigirl wrote:

    As I was reading this I too had thoughts about the ROTH. I am going to convert some money from my traditional IRA to a ROTH before year end and doing my research to determine what stocks I should own in my ROTH. I am conservative in my traditional IRA and plan to assume more risk in my ROTH. I am an active investor and I would prefer individual stocks rather than a mutual fund(s). I learn so much from your excellent articles and hope that you consider sharing your insights on this. Thanks in advance Dan.

  • Report this Comment On October 11, 2010, at 7:54 PM, MegaEurope wrote:

    I don't totally agree with this article. For most people, the tax implications of short term investment vs long term investment are more significant than dividends vs non-dividends. In other words you should keep long term holdings in your taxable account and investments that you might sell within a year in your IRA.

    Obviously, if you trade very little this doesn't apply.

  • Report this Comment On October 11, 2010, at 8:30 PM, TMFGalagan wrote:

    @kbeck02 -

    You ask a complicated question that depends on a lot on your individual circumstances. The question is whether you'd pay more in taxes now by rolling over than you would over time taking withdrawals from your regular IRA. There's no general answer, but you and your tax guy should be able to figure out the pros and cons.


    dan (TMF Galagan)

  • Report this Comment On October 11, 2010, at 8:32 PM, TMFGalagan wrote:

    @gabbigirl -

    This article doesn't address Roth IRAs, but what you're saying is consistent with this article. If you have a Roth available, it's even better than a taxable account - you'll pay no tax on big gains in a Roth, so it makes sense to put aggressive investments there.


    dan (TMF Galagan)

  • Report this Comment On October 11, 2010, at 8:33 PM, TMFGalagan wrote:

    @MegaEurope -

    I agree with you that if you don't plan to hold your investments for the long haul, the tax deferral in a traditional IRA is much more valuable. This article just says that if you're going to be a long-term investor, you may benefit from keeping long-held stocks outside your IRA.


    dan (TMF Galagan)

  • Report this Comment On October 12, 2010, at 2:37 AM, wrkdiver wrote:

    the questions about Roth IRAs are pertinent to me, as I just retired. As i see it, the questions are:

    1) If I defer the taxes on a rollover according to the

    one-time two year rule will I have to pay at today's rate or the new rates?

    2) Can i make enough money in my Roth to "beat the system" and have more to pass down to my heirs? - I figure I have about 30 more years before I go "Tango Uniform" - I just went to my uncle's 100th BD. and he's still plenty sharp.

    3) Should I move to one of those offshore self - directed trusts so I can have a much wider array of investments?

    4) Biggest of all - Will those Washington Bastards snatch our IRAs or force us to put them in Treasuries at a later date?

  • Report this Comment On October 12, 2010, at 9:09 AM, foolsfool4u wrote:

    Be aware that RIG is in the process of instituting about a 6% dividend rate. See:

  • Report this Comment On October 12, 2010, at 9:15 AM, TMFGalagan wrote:

    @wrkdiver -

    Those who defer taxes on a conversion into 2011 and 2012 will pay whatever tax rates apply in those years. It's hard to give specific advice on Roth conversions because everyone's tax situation is different.

    On your last question, you might want to read my colleague Selena Maranjian's discussion of possible Roth shenanigans in the future:


    dan (TMF Galagan)

  • Report this Comment On October 12, 2010, at 3:56 PM, steveelcpo wrote:

    As to the comments about Roth vs Traditional (I have both) when a stock is down, I convert it to the Roth. Tax is lower since the value of the asset being transferred is lower, then when it comes back up, the gain is in the Roth, not the traditional. Experts may disagree, but in the absence of hard numbers, seems the long term benefit of dividends plus (hopefully) capital gains in a Roth outweighs the immediate cost of paying taxes on the transfer. Especially if your income tax bracket is lower. I would also think that this year may be the last year to have a relatively lower tax rate given the realities of the deficit, etc.

  • Report this Comment On December 27, 2010, at 4:14 PM, Gr8Writer wrote:

    Does your advice regarding traditional IRAs also apply to SIMPLE IRAs?

    I was thinking of investing in some long-held stocks in my SIMPLE IRA (including GILD), but am now rethinking that after reading this article.

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