More than 19 million households in the U.S. have Roth Individual Retirement Accounts (IRAs), which accounted for $505 billion in retirement assets at the end of 2013, according to the Investment Company Institute. The retirement savings vehicles are funded with after-tax dollars, meaning distributions are tax-free.
Roth IRA vs. Regular IRA
Introduced in the 1990s, the Roth IRA is the younger sibling to traditional individual retirement accounts (IRAs), which are funded with pre-tax dollars and distributions are taxed as. They are popular with the self-employed, and a portion of the taxes paid at distribution may be deductible depending on the taxpayer's income.
Traditional IRAs are more popular, but Roth IRAs are the fastest growing among the different types of IRAs. The number of households owning Roth IRAs has increased on average 5.3% annually between 2000 and 2013 compared to a 1.3% growth rate for traditional IRAs. (For related reading, see: Can you Borrow from a Roth IRA?)
While there are a few exceptions, you can hold just about any investment in this increasingly popular retirement account. Stocks, bonds, mutual funds, money market funds, exchange-traded funds (ETFs) and annuities are among the choices. (For related reading, see: Roth vs. Traditional IRA: Which Is Right for You?)
Roth IRAs, on average, include three different types of investments per account, Investment Company Institute data reveals. Unsurprisingly, mutual funds are the most common investment in Roth IRAs by a wide margin. They account for 62% of investments and include equity, bond and balanced funds. Equity mutual funds are the most popular by far making up more than half (52%) of the mutual funds in Roth IRAs, while bond funds and balanced funds follow at 27% each. (For related reading, see: Will ETFs Eventually Replace Mutual Funds?)
Individual stocks are the second most common representing 31% of Roth IRA investments, followed by annuities, both fixed and variable, (22%) and money market funds (18%). (For more, see: Can I Buy ETFs for My Roth IRA?)
There are handful investments that you are not allowed to hold in Roth IRAs. Collectibles, including art, rugs, metals, antiques, gems, stamps, coins, alcoholic beverages, such as fine wines, and certain other tangible personal property the Internal Revenue Service deems as a collectible are prohibited. There are exceptions, however, for some coins made of precious metals. (For related reading, see: 5 Investments You Can't Hold in an IRA or Qualified Plan.)
Life insurance contracts are also prohibited as investments. (For related reading, see: Can I Buy Emerging Market Bonds in My Roth IRA? and What Are the Disadvantages of Commodities on a Roth IRA?)
Some transactions and positions are not allowed in Roth IRAs. The IRS does not allow you to invest in your Roth IRA with borrowed money. As a result, investing on margin is prohibited in Roth IRAs unlike a non-retirement brokerage account where margin accounts are allowed. (For related reading, see: Avoiding 'Prohibited Transactions' in Your IRA.)
Margin accounts are brokerage accounts that allow investors to borrow money from their brokerage firm to buy securities. The broker charges the investor interest and the securities are used as collateral. Because margin is leverage, the gains or losses of securities bought on margin are increased. (For related reading, see: Can I Hold Multiple IRAs?)
Certain trading strategies and contracts require margin accounts. This includes, some options contracts, for example, that require borrowing on margin. You also can’t short stocks in Roth IRAs. Short selling occurs when an investor borrows on margin a stock betting that its price will decline. A profit is made when the investor buys back the stock at a lower price. (For more, see: Can I Use My Roth IRA Savings to Buy My First Home?)
Roth and traditional IRAs are a way for investors to save and invest long-term toward retirement with tax benefits, not make a quick profit. Buying and trading on margin is risky and not for the novice or everyday investor. (For related reading, see: What Are the Risks Associated With a Roth IRA?)
The Bottom Line
Roth IRAs are the fastest growing among the different types of IRAs, and some believe paying the tax up front provides an advantage over paying tax on distributions, such as in regular IRAs. Roth IRAs allow for investing in a wide array of investment products, although there are a few exceptions. Check with your brokerage firm to see what it has on offer. (For related reading, see: Roth IRA Tutorial.)