A regular taxable brokerage account offers investors the greatest flexibility — you don’t have to worry about keeping track of contribution limits or withdrawal rules.
However, this flexibility comes at a cost, namely tax drag in various forms. Selling assets above their cost basis incurs capital gains tax, income from bonds and real estate investment trusts (REITs) is taxable, and most stocks will pay quarterly dividends that are also taxable.
While there are some ways to reduce this tax drag, such as focusing on qualified dividends, tax-exempt municipal bond income or holding long enough to qualify for the lower long-term capital gains rate, taxes are inevitable. As the saying goes, “nothing in life is certain except death and taxes.”
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But if you’re okay with observing some fairly straightforward rules, then opening a Roth IRA can provide you with the tax shelter you want, at the cost of some flexibility.
“A Roth IRA is an account that you can contribute after-tax contributions to, with investment returns, income and dividends growing tax-deferred,” explains Scott Krase, a wealth manager at Connor & Gallagher OneSource.
This account allows your contributions to grow tax-free, whether from income, dividends or capital gains, and withdrawals after age 59 1/2 are also tax-free, provided the account has been open for at least five years.
“Roth IRAs are an attractive financial savings vehicle because investors can contribute to them regardless of age and take advantage of tax-free income in retirement, with no required minimum distribution, unlike a traditional IRA, which requires distributions at age 73,” says Tiana Patillo, a financial advisor manager at Vanguard.
However, keep in mind the rules about contribution and eligibility limits. For 2024, the contribution limit is $7,000, with an additional $1,000 allowed for those 50 and older as a catch-up contribution. Your modified adjusted gross income (MAGI) must be less than $146,000, or $230,000 for joint filers, to be eligible to contribute the full amount.
Here are seven of the best mutual funds and exchange-traded funds, or ETFs, to hold in a Roth IRA:
| Fund | Expense ratio |
| Vanguard Wellesley Income Fund Investor Shares (ticker: VWINX) | 0.23% |
| Vanguard Dividend Growth Fund (VDIGX) | 0.29% |
| Avantis All Equity Markets ETF (AVGE) | 0.23% |
| Invesco NASDAQ 100 ETF (QQQM) | 0.15% |
| iShares Residential and Multisector Real Estate ETF (REZ) | 0.48% |
| Fidelity Wise Origin Bitcoin Fund (FBTC) | 0% |
| Global X MLP & Energy Infrastructure ETF (MLPX) | 0.45% |
Vanguard Wellesley Income Fund Investor Shares (VWINX)
“Generally, investors should allocate funds that are less tax-efficient in a Roth IRA,” says Lauren Wybar, senior wealth advisor at Vanguard. “For example, taxable bonds and real estate investment trusts, or REITs, make regular income payments, and actively managed stock funds are more likely to distribute taxable capital gains.” A great example is VWINX, a longstanding Vanguard active income fund.
With an above-average 4.2% 30-day SEC yield and a high 53.4% turnover rate, VWINX isn’t very tax-efficient and is best held inside of a tax-sheltered account like a Roth IRA. That being said, its conservative portfolio of one-thirds dividend stocks and two-thirds investment-grade bonds has historically returned a competitive annualized total return of 9.2% since inception in July 1970.
Vanguard Dividend Growth Fund (VDIGX)
“Roth IRAs are especially beneficial for younger investors because there is greater saving potential due to that tax-free compounding,” Patillo says. For example, the semi-annual distributions from a dividend growth fund like VDIGX would normally incur a tax drag, and investors would thus have less to reinvest. But if held inside a Roth IRA, this distribution would remain intact and allow for more compounding.
VDIGX’s current 1.6% 30-day SEC yield isn’t likely to satisfy income investors, but long-term investors in this fund who reinvested distributions have earned a competitive annualized total return of 10.9% over the past 10 years. Currently, this fund features a concentrated portfolio of 43 high-quality blue-chip stocks for a 0.29% expense ratio and a $3,000 minimum required investment.
Avantis All Equity Markets ETF (AVGE)
Actively managed funds targeting certain types of equities, like small-cap companies or value stocks, can also be great Roth IRA holdings. “These companies have a high discount rate embedded in their market price, and a high discount rate generally drives higher expected returns for investors,” says Ted Randall, senior portfolio manager at Avantis Investors. For a one-ticker solution, Avantis offers AVGE.
AVGE is a “fund of funds” that attempts to outperform the MSCI ACWI (All Country World Index) benchmark by holding 10 other Avantis ETFs, with an emphasis on global small-cap value stocks screened for robust profitability. This package comes at a competitive 0.23% expense ratio, which includes all underlying fund fees and is reasonable for active management.
Invesco NASDAQ 100 ETF (QQQM)
“If you are younger and retirement is still years away, consider allocating a good portion toward funds that focus on growth,” says Jim Penna, senior manager of retirement services at VectorVest Inc. “Historically, these investments have potential for higher growth over time that you will generally pay no taxes on when held in a Roth IRA.” A highly popular growth ETF to use is QQQM.
QQQM is fairly tax-efficient with a low 0.6% 30-day SEC yield, but growth investors who hold this ETF in a Roth IRA can avoid a big capital gains tax bill down the line. This ETF tracks the Nasdaq-100 index, which has a high weight toward all of the “Magnificent Seven” stocks and a tilt toward mega-cap growth stocks in the technology sector. It charges a 0.15% expense ratio.
iShares Residential and Multisector Real Estate ETF (REZ)
“To take advantage of the tax benefits, it is generally better to hold investments in your Roth IRA that would otherwise generate taxable income,” Penna says. “For example, stocks that pay dividends or generate capital gains, real estate investment trusts, or REITs, known for favorable dividend payouts, and high-yield bond funds fit into this category.” An example would be REZ, a unique REIT ETF.
Unlike broad REIT ETFs, REZ tracks the narrower FTSE Nareit All Residential Capped Index. This means the ETF only holds residential, health care and self-storage REITs, while eliminating exposure to retail and office REITs. This makes REZ a suitable holding for real estate investors looking to reduce exposure to riskier industries. The ETF charges a 0.48% expense ratio and pays a 2.8% 30-day SEC yield.
Fidelity Wise Origin Bitcoin Fund (FBTC)
“Acting as a tax-free piggy bank, Americans can use Roth IRAs to invest in high-growth assets while maximizing their tax savings in the future,” says Chris Kline, chief operating officer and co-founder of Bitcoin IRA. “It’s one of the reasons Bitcoin — whether via ETFs or direct custody in self-directed IRAs — is becoming a popular choice to diversify within retirement accounts.”
Even large, traditional asset managers have gotten with the times and begun offering their own Bitcoin ETFs. For example, this ETF from Fidelity is a spot Bitcoin ETF, meaning that it actually tracks the live Bitcoin price by holding real Bitcoin in custody. It is free to invest in, with an ongoing fee waiver, but will begin charging a 0.25% expense ratio on Aug. 1.
Global X MLP & Energy Infrastructure ETF (MLPX)
Incorporated energy pipelines and master limited partnerships (MLPs) often feature high yields thanks to their stable, above-average cash flows. That being said, this yield can be subject to significant taxation outside of a Roth IRA. In addition, directly holding an MLP can cause investors to be issued a Schedule K-1 form, which is generally considered a nuisance to file for tax reporting.
To avoid both of these issues, investors can buy and hold an ETF like MLPX in a Roth IRA. This ETF tracks the Solactive MLP & Energy Infrastructure Index, which holds 25 MLPs and incorporated pipelines in a tax-efficient, K-1-free structure. If held in a Roth IRA, the ETF’s 5.7% 30-day SEC yield is also tax-free, allowing you to reinvest the quarterly distribution at full potential. MLPX charges a 0.45% expense ratio.
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7 Best Funds to Hold in a Roth IRA originally appeared on usnews.com
Update 06/20/24: This story was previously published at an earlier date and has been updated with new information.
