Imagine being able to invest money in a stock steadily for several years, or ideally decades, and watching the stock appreciate significantly enough to turn your investment into a large windfall. Next, imagine selling that stock when you're sixty years old and not paying any taxes on your gains -- zero, zip, zilch going to Uncle Sam.
Sound too good to be possible? Well, count your blessings, because it is possible, and it has been for only a few years.
Unveiled in the late 1990s, the Roth IRA allows qualified individuals -- which is a majority of us -- to invest as much as $2,000 annually (recent legislation raises this limit to $3,000 for 2002 through 2004, and higher in following years). Once that money is qualified for withdrawal from a Roth IRA, you can withdraw it without paying taxes on the gains that you have earned with the money. This makes the Roth an incredible tool for retirement investments.
The only problem for us in Drip Port is that dividend reinvestment plans (or Drips) are rarely offered as IRAs, let alone as Roth IRAs. An IRA requires a custodian, which is usually a broker or a bank, and the custodians typically charge an annual fee for the IRA. Only a small handful of Drips offer IRAs, and they all appear to be traditional IRAs, not Roth IRAs. But some of these plans, despite the extra fees involved, are well worth considering. Drips that include an IRA option are offered by the following companies (among a few others):
Atmos Energy Corp.
Connecticut Energy Corp.
Connecticut Water Service, Inc.
Exxon Mobil Corp.
Morton International, Inc.
SBC Communications, Inc.
UtiliCorp United, Inc.
But there's a new way to have a Roth IRA
Despite the lack of a Roth IRA option in traditional Drips, in the last few years a new low-cost investing option, one that mimics Drips, makes Roth IRA investing easy and very inexpensive. This one-two punch -- very low commissions coupled with the Roth IRA's eventual tax-free withdrawals -- makes much more of your money work for you, and not for brokerage houses or the government.
Roth IRAs are relatively simple. The most pertinent facts to know are that you can only contribute up to the set amount in them per year and if you withdraw the money when you're not yet qualified, you'll pay taxes on your gains as you normally would. If you withdraw the money at age 59 1/2, you won't pay taxes on your gains.
Dripping in a Roth IRA
New, low-cost discount brokerages including ShareBuilder.com and BuyandHold.com offer IRA accounts, both Roth and otherwise. (I didn't find any extra fees on the IRA account with either service.) This means that you can open an account with either (free of charge), open it as an IRA, and begin to invest up to $2,000 this year (and more in later years) in your choice of stocks at very low trading commissions. Upon retirement, all the money compounded in your Roth IRA is yours to keep.
This great, tax-free benefit is substantial enough, in my opinion, to justify paying an approximate $3 per trade in commissions over the years, especially if you buy frugally, rather than several times a month. Everyone who can probably should take advantage of IRA accounts, and doing so through a low-cost brokerage service that allows you to "Drip" into stocks and reinvest dividends is smart.
You can also set up IRA accounts with index fund providers such as Vanguard, which also allow you to invest small amounts of money regularly. (By the way, the time to start saving for your retirement is now. Our self-paced retirement seminar can help you build a comprehensive plan.)
Will Drip Port's next purchase be in a Roth IRA?
Although none of our high-growth company finalists have free Drips anymore, we could buy any one of the companies in a Roth IRA through, for example, ShareBuilder, and then pay just $3 per purchase (so maybe $12 per year). Given that opening a Drip now costs us about $30, it'd be nearly three years before we exceeded that expense anyway, and meanwhile, eventually, all of our gains would be tax-free, which is better than we can say for traditional Drips.
This, to me, sounds like a very viable solution for investors who want to Drip money into high-growth companies that don't have Drips. You should more than make back your commissions by saving on taxes in the end. (If Drip Port were to go this route, it would also serve as a standing educational tool for all readers who come along, which is always good.)
What do you think? Should Drip Port consider a Roth IRA through a low-cost broker for one of its holdings? Post your thoughts on the Drip board. And if you don't have an IRA yourself, consider one as another step toward your Financial Independence. Start by reading the Fool's excellent articles all about IRAs.
Happy Fifth of July! (By the way, if you missed our short Fourth of July Rule Breaker column in 2000, here it is.)
The Motley Fool has a full disclosure policy. Jeff Fischer doesn't own any of the stocks mentioned in this column and doesn't have an IRA yet. It's high time to start.