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Author: edyboom223 Big red star, 1000 posts Old School Fool Ticker Guide CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Roths with Dividends and Options Date: 2/17/2010 12:53 AM
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I recently decided to shift my philosophy, and I would like some opinions as to what other people think of this idea. Personally, I think it's great, but I want to see if someone else can prove me wrong.

I am 26, and I started my Roth IRA when I was 23. I have funded it fully every year. I used to do mostly "risky" stocks...international and small/mid caps. In the past year, I have decided to shift it to 40% dividend payers and 60% of the "risky" ones. I had planned on gradually shifting it to 60% dividend, 20% bonds, and 20% "risky" with age.

Now, I have a new plan, and unless somebody can prove to me that this is a stupid idea, I plan on following through with it (unless someone shows me something better or I come up with something better in the future).

I will admit that a large part of my shift in philosophy is because I have joined the Motley Fool Options newsletter, and I like the idea of writing calls for income. I plan to use that strategy in the future. Anyways, here is my idea.

From now on, I will continue to max out my Roth at $5,000 a year. I know that the limit will go up with time, so my goal is to put $4,000 of it (or 80%, depending on future raised limits) in solid dividend paying companies (likely income investor pics) and $1,000 in whatever else I choose (a mix of call options and the "risky" stocks most likely).

Furthermore, I currently make about $280 a year in dividends. I have a goal of having my companies raise their dividends by 10% a year. Additionally, I intend in investing in companies with an average dividend of 3%.

Now, I will do this until I am 50 years old ($4,000 a year in dividend stocks with yields of 3% and dividend growth rates of 10%). 3% of $4,000 is $120, so that is how much my dividends should grow through acquisition a year. Additionally, I want them to grow 10%. So, to calculate my dividends up to the age of 50, I am doing this:

280 (my current amount in annual dividends) x 1.1 (dividend growth rate) + 120 (new 3% from the $4,000 in dividends per year) = $428 in dividends when I am 27 years old

$428 x 1.1 + 120 = $590 in dividends when I am 28 years old.

If I continue this pattern up until I am 50 years old, I come up with

$965 a year in dividends when I am 30
$4,417 a year in dividends when I am 40
$13,371 a year in dividends when I am 50.

I realize that much of this is a wait and see how it goes type of thing, but if all goes well, I will stop putting new money in the market when I am 50, but my dividends will continue to grow at 10% a year.

$13,371 x 1.1 (ten times to the age of 60 will make my dividend at age 60 be...) = $34,681

Now, with a Roth, I can take out as much money as I have invested in my life at any age. For example, if I have invested $40,000 in a Roth, and it grows to $50,000, then I can take out $40,000 tax free. If I take out anything over the $40,000 I have invested before 59.5, then I am taxed and penalized on it.

Additionally, if I add $ to my Roth up until the age of 50, I will have invested a total of 25 years at $5,000 and 2 years at $4,000 = $133,000.

Again, at age 50, I will be making $13,371 a year in dividends. Since this is a Roth and I can take up to $133,000 out of the IRA tax free, I can take out $13,300 a year for 10 years until age 60 (I realize its 59.5, but I'm keeping it simple) when I can take out as much as I want tax free.

If I were to do this, then I would invest virtually nothing at age 50 ($13,371 - $13,300 = $71), but at age 51, 52 and so on, the dividends would continue to grow at 10%, so the growth from that would also fund the IRA until age 60.

I realize that there are many arguments that could be made about why this strategy would fail. Many would say that I cannot get 10% dividend increases a year. I realize that this is true. I realize the market may be volatile, and that bad things may happen at my companies and cause them to lose value or cut their dividends. This is obviously a good case scenario, but I don't think it's totally unreasonable or a great scenario, and here is why.

In this model, I am not accounting for reinvested dividends. I believe that it is made very clear at the Fool that reinvesting dividends can lead to spectacular returns given a long period of time. I am only 26, so I have 34 years to wait. I hope that's long enough to reap some rewards from dividend reinvesting. While I may not get 10% a year in dividend increases, I believe that I can easily bump the value up from whatever the true value ends up being to 10% a year through dividend reinvesting.

Also, I noted that I intend on writing calls as another source of income. With the income from these calls, I may very well invest even more in my dividend paying stocks (of which I would like to own 15-20). I realize that this isn't really reinvestment, but in my mind, it's somewhat like that because I will be making money from the options to invest in the company.

The last factor not listed here that should boost my returns is that I will be using the (hopeful) gains from my buying call options (specifically, LEAPS) and "risky" stocks to put more money into my dividend paying stocks.

Obviously, this is a vague outline of my idea, but my main questions are these:

1. Does this seem unreasonable?
2. Am I misunderstanding any of the tax laws?
3. Does any of my math seem horribly wrong?
4. (The most important one) Can I use my dividends from my Roth to supplement my income from ages 50-60 as stated above if I choose to do so?

Please let me know if you see any fatal flaws in this idea. Everyone's help will be greatly appreciated. I am hoping for a lot of feedback here, because I feel that this is not the most common thought process that people have with a Roth. Though I'm hoping for praise for a genius idea, feel free to rip me apart as I realize that many of you out there are more knowledgeable than me. I've been a loyal Fool for 3 years and I've learned a lot, but I always rely on the community to fall back on and provide me with more information.

Fool On

Edyboom

P.S. I realize that it's normally inappropriate to talk specific $ amounts here, but it's much easier and helpful for me to use real amounts than it is to make up fake numbers and then try to go back and forth and change them to my own once others respond to my numbers. Sorry to anyone who finds it inappropriate. Additionally, this is a cross post that I also put on the HG Philosophy board and Options Philosophy board.
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