Investments in a Roth individual retirement account grow tax free and can be withdrawn in retirement tax free. This is a tremendous saving to be used by investors. Because only $5,000 a year can be placed into this account, an investor may have to divide his investments between his Roth IRA and another account. The best bonds to be put into a Roth IRA are those with the highest payments or greatest tax liability, as they make the most of the Roth IRA's tax savings.
High-yield Corporate Bond Funds
High-yield corporate bonds are sold by companies that do not qualify as investment-grade bonds. High-yield bonds have lower credit ratings from the rating agencies; for example a rating of less than "BBB" from Moody's Investors Service is considered high yield. Because of their greater risk, high-yield bonds pay greater interest payments than investment-grade bonds. High-yield bonds are useful in a Roth IRA, as the investor will receive the higher interest payments tax free.
Long-term Treasury Bonds
Long-term treasury investments pay a higher interest rate than short-term treasury investments. This is to compensate for the risk of investing in a longer term contract. To maximize the tax savings of a Roth IRA, bonds with the highest annual interest payments should be placed inside. The best treasury bonds to be placed in a Roth IRA are those with the longest term; usually 20- or 30-year treasury bonds.
Zero-coupon bonds do not pay annual interest. They are purchased at a discount from their face value and the investor profits when the bonds mature. Because they do not pay interest, zero-coupon bonds only pay cash to an investor on their maturity. Income taxes are still due each year on the accrued interest, the investment gain by the bond getting closer to maturity. This can create a liquidity problem for investors. Putting zero-coupon bonds into a Roth IRA will avoid this annual taxation.
Worst Bonds for a Roth IRA
The worst bond that can be put into a Roth IRA is a municipal bond. The federal government exempts municipal bonds from federal taxes. This is done to give states and counties a boost in raising funds. Because the payments from municipal bonds are already tax free, putting them into a Roth IRA wastes its tax advantage. Short-term bonds and investment-grade bonds should also be avoided if possible. Their interest payments are lower and do not take the full advantage of a Roth IRA's tax savings.
- "Fundamentals of Investments for Financial Planning"; Walt J. Woerheide; 2008
- Investbonds.com: About Municipal Bonds
- U.S Securities Exchange Commission: Zero Coupon Bonds
- IRS: Roth IRAs
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