Based on searches that lead people to Six Figure Investing, these are the top investment questions people ask about IRAs. For definitive answers to tax questions in your specific circumstances please consult a tax professional.
- Why trade in an IRA? Because it allows you to defer or avoid taxes on dividends and capital gains—all of your profits can be reinvested tax-free.
What trading restrictions / rules are there for IRAs? The only universal restriction is tied to IRS rules that do not allow borrowing from an IRA account. This restriction blocks short selling, leverage using margin, and the sale of naked put or call options. Brokerage firms vary in what they allow, but generally, you can trade all stocks and exchange traded products (ETFs & ETNs) including leveraged (SSO), inverse (e.g., SH), and volatility funds (e.g., VXX, XIV, ZIV). Some trades such as options, leveraged/inverse funds, volatility funds, or futures might require extra paperwork / qualification.
- What specific restrictions/features do brokers put on their IRA accounts? Data on a few brokers:
- Are the trading rules for a Roth IRA different from a Traditional IRA? There are no differences that I’m aware of.
- Can I day trade in my IRA account? Typically there are no pattern day trader restrictions on IRAs that have a value of more than $25,000. However frequent trading in a cash account (typical for IRAs) can lead to violations of the 3 day trade settlement rule. Unless you are only trading a small percentage of your account balance you will quickly run into settlement problems. If you break these rules you will get “free riding” or “good faith” warnings/violations (SEC Regulation T violations) that will cause restrictions to be put on your account. See “Trading in an IRA and avoiding free-riding” for more information.
- Is there an easy way to avoid “free riding” in my IRA account? Only buy when you have enough “settled funds” in your account (usually visible in your on-line balances) to cover the purchase. Interactive Brokers and TD Ameritrade have limited margin features for avoiding settlement date restrictions—they essentially waive the 3 day settlement period.
Stock/ ETF/ ETN trading
- Can I buy stocks on margin in my IRA? Not if you are trying to get leverage. While some brokers offer IRAs with limited margin, that capability is only there to manage options strategies and avoid cash settlement issues.
- Can I sell stocks short in an IRA? No, but you can buy inverse Exchange Traded Products (ETPs) like SDS (-2X S&P 500) or SH (-1X S&P 500). With options you can often nearly replicate a short position—by buying puts, or call spreads with the short side deep in the money.
- Can I buy leveraged or inverse ETF / ETNs like SSO (2X S&P500) in my IRA? Most brokers allow this. You may have to sign a waiver or be qualified first.
- Can I buy volatility ETNs/ETFs like VXX, UVXY, and XIV in my IRA? Most brokers allow this. You may have to sign a waiver or be qualified first
- Can I use a stop loss order in my IRA account? Yes, but for stocks / ETPs you should wait 3 days after your purchase to put it in place if you used unsettled funds for the purchase. Otherwise you run the risk of violating the SEC’s free-riding rules if the stop loss triggers. See this post for more information.
- Can I trade options in my IRA account? You need to be qualified and allowed trades vary between brokers, but yes you can—except for selling naked calls or puts—the highest risk category.
- What happens if options in my IRA are assigned? Option assignment can be a problem if it not covered by cash or offset by other positions in your account (e.g., stock in the case of a covered call, or an offsetting assigned option). For example, if the short side of your vertical spread is assigned when the underlying goes ex-dividend your account will go short the equivalent amount of the underlying—not a sustainable situation for an IRA account. You must cover the short quickly, but unless you have sufficient settled cash in your account you may get a “free ride” violation (see Trading in an IRA and avoiding free-riding). A call to your broker if this situation occurs would be a very good idea. It might be possible in this case to wait one day before covering and avoid the violation. Unbalanced option assignment can also happen when the options in a spread expire with one leg in the money and the other OTM. Cash settled options (e.g. SPX, VIX) don’t have this problem. See Options strategies in Your IRA Account for more information. Index options are nice because they are usually european style options that can’t be assigned before expiration—totally dodging the problem, however there may be some restrictions on them when used to create spreads with different expiration dates.
- Can I sell puts in my IRA? You can sell cash secured puts in your IRA if you have approval for that level of options trading from your broker and you have enough cash in your account to buy the requisite amount of the underlying security (100 shares per option) if your puts are assigned. An alternative is to open put spreads where the long leg strike price is well below the short leg. This approach doesn’t tie up as much cash and allows limit orders at the lowest possible increment (e..g, one cent for equities).
- Can I write off a trading loss in my IRA on my taxes? Generally no. Only if you have liquidated the account and your distribution was less than the amount you contributed. Of course the converse is also true; you don’t have to pay taxes on gains. The IRS always seems to have exceptions so check with your tax advisor if you have questions.
- Will my dividends or capital gains be taxed in my IRA? No, taxes on dividends and capital gains are either deferred (traditional) or avoided (Roth) in an IRA.
- Can I write off commissions on my trades within my IRA? No, the tax exemption cuts both ways. There’s no way to write off expenses like commissions or management fees.