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Tax Free Stock Investing

Updated on September 23, 2010

 You may have heard the simple analogy from financial advisers, "Buy low, sell high." This refers to the purchase of stock investments. The opportunities for purchasing stocks at rock bottom prices tend to come in tough economic times when people have less faith the stock market will yield the same money-generating results of the past.

The other part of stock investing has to do with capital gains tax. Every time that you purchase a stock, if it goes up and you sell it for that gain, you own a percentage of tax on it. Capital gains tax can be substantial and is a deterrent for some who would like to invest in stocks, but do not want to pay or cannot afford to pay capital gains taxes. There is a way to avoid these taxes completely.

The Roth IRA

A Roth IRA is an IRA (individual retirement account) that allows you to install investments into the vehicle for tax free growth and distribution. You pay the taxes on the dollar amount that you are investing up front. Traditionally, IRAs grow tax free and you are not taxed initially, but when you withdraw your money, you are taxed on all distributions as ordinary income. So the Roth IRA is a great way to have tax free income at retirement.

Stock Investing Within The Roth Vehicle

Because of the tax free structure of the Roth IRA, the other wonderful thing about it is that it is specifically beneficial for stock investors. Stocks are bought and sold within a stock portfolio every year to take advantage of market swings which makes them more flexible than mutual funds. Typically you are charged a capital gains tax on investments sold. In a Roth IRA, you can buy and sell stocks with the funds already in the account as much as you want with no tax consequences. This is extremely advantageous for investors going from working life to
retirement life, not to mention the ability to pull tax free income from the Roth IRA fund.

General Rules

Roth IRAs do not have RMDs (Regular Mandatory Distributions) so if you do not need to use the money in your old age, you do not have to. You can also withdraw money from your Roth without penalty in case of emergency prior to retirement. Maximum capital investment amounts are currently $5,000 (2010) or $6,000 with catch up contributions (50 and over).

The stock investing does not have to be any more risky than investing in mutual funds. You can buy the same stocks that all of the mutual fund companies are buying and pick and choose which ones to keep and which ones to sell. Doing this in a Roth IRA will give you the tax free income that you need in retirement to supplement your long and prosperous life.

Not all investors are able to take advantage of this great product due to mandated income cut-off points. If you make over $150,000, consult your financial advisor about a Roth IRA investment vehicle to see if you are able to contribute to this type of plan.

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