Roth IRA Stocks Versus Mutual Funds

by Mike Parker

Congress first permitted the creation of tax-advantaged individual retirement accounts, or IRAs, in 1974 as part of the Employee Retirement Income Security Act (ERISA). These early plans were limited to only self-employed taxpayers, or workers who did not have access to a qualified retirement plan at work. Subsequent legislation expanded the availability of IRAs to most working Americans, and introduced the tax-advantaged Roth IRA as an alternative to the traditional version. You can put a wide variety of investments into a Roth IRA, including stocks and mutual funds.

Roth IRA

A Roth IRA has some similarities to a traditional IRA in that earnings generated within the account do not result in a taxable event until they are withdrawn. Contributions you make to your Roth IRA are made with after-tax dollars, so you can withdraw them at any time without any tax consequences. Earnings on your contributions must remain in the Roth IRA for at least five years, then you can withdraw them tax-free after you reach age 59 1/2.

Stocks in a Roth IRA

You can buy stocks with funds in your Roth IRA. You can trade stocks inside your Roth IRA without generating a long-term or short-term capital gain or loss. Any dividends earned by stocks in your Roth IRA are allowed to accrue without creating a taxable event. You can reinvest the dividends into additional stock, or invest those funds in a different type of security.

Mutual Funds in a Roth IRA

You can buy shares of mutual funds with funds in your Roth IRA. Mutual funds within an IRA have the same benefits as mutual funds outside an IRA, including professional management and diversification. Mutual funds inside an IRA have the added benefit of tax-deferred growth. Capital gains and dividends generated by the mutual fund within a Roth IRA do not create a taxable event.

Pros and Cons

Investing in stocks or mutual funds involves certain risks, regardless of whether or not these investments are held within a Roth IRA. Prices of either type of investment may fluctuate either up or down. You may make money on these securities, but you may also lose some or all of your investment. Neither stocks or mutual funds are insured or guaranteed by any agency of the federal government. Past performance by any stock or mutual fund is never a guarantee of future results. Non-qualified withdrawals from your Roth IRA will create a taxable event, and will result in an additional tax penalty of 10 percent of the non-qualified amount withdrawn.

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