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Reward Yourself With Tax-Free Dividends in This Special Account

By Charlene Rhinehart, CPA - Feb 7, 2021 at 8:41AM

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Don't miss out on this opportunity to grab an extra source of income that you won't have to split with the IRS.

If you haven't heard about the Roth IRA yet, you may be missing out on a rare opportunity to accumulate tax-free income. As we all know, it's not easy getting your hands on income that the IRS won't require you to pay taxes on. So if you find the secret sauce, you have to jump on it. Here's what you need to know to earn tax-free dividends in one of the most desired investment accounts on the planet. 

How the Roth IRA works

The Roth IRA (individual retirement account) is one offer you don't want to pass you by. It's the perfect way to accumulate tax-free income that you'll have access to forever. To qualify, you must have earned income for the year and fall below the annual income thresholds

Red bow on a stack of one hundred dollar bills. Isolated white background.

Image source: Getty Images. 

This special retirement savings account allows you to contribute up to $6,000 (if you're under 50) of earned income that you've already paid taxes on. If you're 50 and over, you get a $1,000 contribution bonus that allows you to fund your account with a maximum of $7,000 every year. Simply put, this retirement goodie has its limits and you cannot contribute more than the maximum allowed every year. On the other hand, if you don't want to contribute anything in a certain year, there's no obligation to fund the account. But you'll never be able to turn back the hands of time and make up for a year in which you failed to contribute. 

You won't get any tax deduction on the money you contribute to the Roth IRA, but all of your earnings grow 100% tax-free. After you've had your account open for at least five tax years since you've made your first contribution and have reached age 59 and a half, every dime in your Roth IRA is yours to enjoy -- no need to share your earnings with the IRS.

Dividends in retirement accounts 

The worst thing you can do, though, is to make a contribution to a Roth IRA account and then just let the money sit there. That defeats the purpose of the tax-free benefits on earnings if your account isn't investing in assets that allow you to earn money.

A great way to grab an extra stream of income in your retirement account is to invest in dividend-paying stocks. You can look at dividends as a reward for buying company stock and holding it for a period of time. Most companies pay dividends quarterly but there are some companies that will provide you with monthly dividend deposits.

Typically, an investor would have to rely on capital appreciation -- buying a stock at one price and selling it at a higher price -- to earn money in the stock market. But there are elite companies like Coca-Cola, Colgate-Palmolive, and Lowe's that have been compensating investors with dividends for decades, providing a recurring stream of income that keeps going and growing. 

Earning money in the stock market is great, but it usually comes with a cost: capital gains taxes. Fortunately, you can skip taxes when you invest in a Roth IRA account. Now you can truly enjoy the power of compounding, and expedite your wealth goals without worrying about a tax bill at the end of the year. 

Fund your lifestyle 

The best thing about dividends is that you can strategically create a plan to earn enough dividends to fund your entire lifestyle. If you want to earn $20,000 a year in dividends, there's a strategy for that. If you need $50,000 a year to maintain your lifestyle, there's another master plan for achieving that goal. There is no limit to the amount of dividend income you can earn. The concept is pretty simple: The more dividend-paying stocks you invest in, the more money you earn.

You don't have to worry about not getting your income unless the company suspends or cuts dividends. As long as the board of directors declares a dividend, you can expect to see deposits in your account. 

A limited time offer 

You may not always be eligible to contribute to the Roth IRA. If your income moves past the thresholds, you won't be able to make a direct contribution.

If you qualify, now is the best time to do whatever it takes to max out your Roth IRA. Your window of opportunity may be fading away but once you start investing, you'll be able to enjoy an extra stream of tax-free income for life.



This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

The Coca-Cola Company Stock Quote
The Coca-Cola Company
KO
$53.54 (0.89%) $0.47
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
LOW
$248.69 (-0.68%) $-1.70
Colgate-Palmolive Company Stock Quote
Colgate-Palmolive Company
CL
$76.77 (1.71%) $1.29

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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