The clock is ticking to meet your 2011 contribution maximum in your individual retirement account (IRA). But if you've got a few minutes to spare ahead of the April 17 deadline, think about "carbo loading" your IRA.
The energy-boosting carbohydrates in this case: dividend-paying stocks.
Dividends are back in vogue as other income sources (the bond market, for one) disappoint, although their popularity has eased a touch from last year. Companies with the best track records of paying dividends are lagging the rest of the stock market this year. Their "safe-haven" status (think utilities, for instance) lost a little luster once the immediate danger of the European debt crisis eased.
The S&P 500 Dividend Aristocrats Index, which tracks companies that have raised dividend payouts for at least 25 straight years, returned 7 percent in the first quarter of 2012, trailing the 11 percent gain for the broader S&P 500. The Aristocrats paid out 8.3 percent, compared with the broader S&P 500's 2.1 percent last year.
There's room for dividend-investing growth, however; the data show that S&P 500 companies are paying out 30 percent of their profits, shy of the long-running 52 percent average. Given prospects for upward movement, and over time, capital appreciation, many analysts remain bullish on dividend stocks.
IRAs factor into the equation because not only do you not have to file and pay taxes on your IRA-housed dividends, you can let them grow—compound, even—right in the account.
Of course, buying any investment simply for a tax advantage is ill-advised. You must like the stock for other reasons, too.
Here are some features to consider:
• Are company fundamentals and earnings projections strong? Remember, companies can cut or suspend their dividends if they need to.
• Look into the numbers. Just because a company is offering an attractive dividend yield, say in the 5 to 8 percent range, doesn't mean it's going to stay there. Find out: Is the company in a pattern of cutting, raising, or holding fast to their current dividend?
• There's a bonus to a dividend that's on an upward tilt. It's likely to attract new buyers, and that will help push up share appreciation. Again, check the S&P 500 "Aristocrats" for ideas.
Keep in mind that a dividend shopping spree probably makes more sense for a traditional IRA, which typically permits an annual tax-deductible contribution, rather than a Roth IRA. For 2011, your contribution limit is $5,000 (if you're over 50, $6,000) per person. That means married couples can contribute up to $10,000 total to their IRAs.
If neither you nor your spouse is an "active participant" in an employer-sponsored retirement plan, you both may deduct your entire traditional IRA contribution, up to your applicable limit. However, if either of you participate in an employer-sponsored retirement plan, such as a 401(k), you may deduct your contribution only if your adjusted gross income falls within certain ranges. Wells Fargo offers this table.
With a traditional IRA, after the deductible contribution, the money grows tax-free until you withdraw it at age 59 1/2 or later. At that time, you'll need to pay ordinary income tax on the distribution you receive. The Roth, while not permitting a tax-deductible contribution, does allow for a tax-free distribution of both contributions and earnings under certain circumstances.
With IRAs, there's a tax-convenience factor, too. Ordinarily, when you invest, you have to keep track of every purchase, every sale, and every dividend payment received. With an IRA, no tracking of individual actions required for taxes.
Let's face it, when you adding up the savings at tax time, it's hard to put a price on convenience.