ETFs offer an efficient and accessible way to gain exposure to a range of asset classes and commodities; investment themes like energy or health; countries or regions.
ETFs differ from mutual funds in that they trade continuously on an exchange, typically at lower fees and may offer tax advantages over conventional brokerage accounts for certain precious metals and energy commodity funds held within an IRA account.
Taxes
Individual retirement accounts (IRAs) offer unique investment flexibility. Furthermore, tax-deferred accounts allow investors to enjoy dividends or realized gains without incurring taxes at tax time if investments remain in their IRA for at least 5 years after purchase.
ETFs are popular choices in taxable brokerage accounts because they provide an affordable way to diversify investments across different markets or sectors of the economy. Investors should keep in mind, however, that ETFs may generate capital gains distributions which are taxable.
ETF dividends are generally taxed as ordinary income depending on how long you’ve held onto the fund, similar to mutual fund dividends. For instance, when investing in Schwab U.S. Dividend Equity ETF (SCHD – Free Report), for instance, dividends received are taxed anywhere from 0%-20% depending on how long you’ve held it; similarly leveraged ETFs may generate realized capital gains that are also taxable.
Fees
Individual retirement accounts (IRAs) allow investors to invest pre-tax dollars toward building retirement wealth. Mutual funds were traditionally seen as the best way to diversify or gain exposure across market segments, however ETFs have gained in popularity as they cost less to own and trade more like stocks throughout the day.
ETFs do not impose the same administrative costs that come with traditional open-end mutual funds that must send statements and reports out regularly to thousands of investors, so ETF companies pass along some of their savings through lower expense ratios to their customers.
One drawback of investing in ETFs may be having to purchase whole shares rather than fractional ones, which can diminish your investment power. Although more custodians now offer this option of fractional ETF shares, commissions still apply when buying and selling ETF shares – plus any associated incremental costs such as expense ratios are added into the price of owning them!
Trading
ETFs can make an excellent addition to your retirement account portfolio. Their low expenses often make them the better value than actively managed mutual funds, and ETFs provide exposure to both developed and emerging economies – Vanguard Total International Stock ETF VXI holds global companies such as Samsung, Toyota, Nestle, etc.) They may even help diversify your IRA with foreign markets (Vanguard Total International Stock ETF VXI boasts both!).
ETFs with high income distributions could add to your retirement-income stream without significantly adding to total returns. Schwab U.S. Dividend Equity ETF SCHD offers such an option; it features a carefully constructed index portfolio of disciplined dividend stocks with strong fundamentals. But don’t mistake tax efficiency with tax immunity: investing in precious metal ETFs could be treated like buying collectibles; any gains will still need to be reported and taxed as they would in a taxable account.
Investments
A traditional IRA can hold virtually any investment imaginable, from stocks and bonds to mutual funds, ETFs, annuities and UITs (unit investment trusts) – even real estate! By deferring or sheltering capital gains or income until withdrawals occur in retirement, an IRA allows its holders to reduce taxes during this period of time.
ETFs are popular investments within IRAs due to their ease of investing. Trading like stocks during market hours, ETFs provide access to a basket of various assets at once; unlike mutual funds which must buy or sell assets at their net asset value every day at midnight, ETFs can be bought or sold throughout trading day.
Investors who sell an ETF for a profit must pay taxes based on how long they held it, making ETFs ideal investments for long-term holding in an IRA account. Dividend-paying ETFs like Schwab U.S. Dividend Equity ETF (SCHD – Free Report) provide further tax advantages as their income remains tax deferred or even shielded.
