Do Low Dividend Stocks Belong In A Roth IRA?

The wisdom of holding a high dividend stock within the tax-protected confines of a Roth IRA is pretty self-evident because you are protecting the total returns of a cash-generating asset from the taxman by not exposing yourself to the dividend tax. For instance, a $10,000 investment in BP (BP) over the past twenty years has paid out a total of $30,063 in cash dividends to its owners. With a payout like that, it makes strategic sense to protect that income from the 15% (or more) annual tax bites that would nibble at your gains with each passing year. The appeal of keeping your cash cows like oil giants, tobacco companies, and telecom firms inside of a tax-protected structure is that a lot of the total return consists of the dividends, and you wouldn't want to see that portion of your total return claimed by the government.

A more interesting dilemma is trying to figure out whether companies with low dividend yields, perhaps in the range of 1% or 2%, are worthy of consideration for your IRA. The easy kneejerk response is to say "no they don't." The reason why companies like IBM (IBM) may appear suboptimal in something like a Roth IRA is because most of the company's profits are naturally shielded from taxation; in the case of IBM, the company generates $14.47 per share in profits while only paying out $3.80 to shareholders as a dividend. Holding the low yielders with high growth rates for long periods of time can give you options. With that $400,000 in IBM stock, you could convert it to a collection of oil giants, tobacco companies, REITs, and telecom companies that give you $20,000 in tax-free retirement income from the share of those profits alone.

Source: Seeking Alpha

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