Trading Restrictions in an IRA


Updated: Apr 21st, 2015 | Vance Harwood


IRAs are attractive to investors because they enable taxes on dividends and profits to be deferred (traditional IRA)  or avoided (Roth).   To a large degree you can do the same trades in an IRA that you can do in your regular accounts.  However there are significant differences, and the differences change over time as brokers adjust their policies, and their software.   I’ve tried to summarize the differences below.

Brokers vary in what transactions they allow in your IRA, but one restriction mandated by the IRS is that you cannot use your IRA as security/ collateral for a loan.   Getting leverage using margin and selling equities short involves using the assets in your account to secure the loans so those trades are definitely out in an IRA.

The no-loan restriction can also impact how often you can trade in your IRA account.   Since funds from equity sales take 3 days to settle, just like a regular non-IRA account, you can run into free-riding/ good faith violations if you do  buy / sell sequences before your previous trade’s settlement.   Some transactions like stop loss orders or option assignments can sell out your positions automatically, so you need to assess the risks of that happening within 3 days of your purchase.  For more on free-riding see this post.

If you only buy securities when your account shows enough cash to cover the purchase as “settled cash”, or “cash available to withdraw” then you won’t violate the rules—even if you sell it five minutes later.  It’s only when you are dependent on an upcoming cash settlement from a previous sale that you have to be careful.  So if your cash balance is large compared to your trade size (e.g., $10K cash, $2K trades), then you could do up to 5 trades in a 3 day period before you had to worry about the settlement timing.

If you are trading indexes then the short sale restriction is often easy to circumvent by buying the corresponding short or leveraged short, 2X, 3X ETF (e.g, SH, SDS, SPXU for the S&P 500, PST and TBT for treasuries).    In my experience any stock/ETF/ETN that can be bought in my regular account can be traded in an IRA account—so for example long, leveraged, and short volatility funds like VXX, TVIX, and XIV are allowed.

There is more variation between brokers on what options transactions are available in your IRA.  None of them allow selling of naked calls or puts, but I know Fidelity and OptionsXpress, but not  Schwab support vertical spreads in their IRA accounts.  Generally long puts and calls, covered calls, and cash secured equity puts are allowed if you are approved at the appropriate option levels.    Cash settled options positions are actually easier to manage since they can’t result in of equity purchases / short sales if the options expire with the underlying’s price between the two strike prices.  In addition cash settled options (e.g., VIX and SPX) are often have European style exercise, which means they can’t be assigned until expiration.  This is a nice feature for options spreads where you typically don’t want one leg of your spread to turn into a long or short equity position.

Several firms (Fidelity, optionsXpress) offer limited margin accounts in their IRAs to support buying/selling options spreads.  It appears  that Interactive Brokers and TD Ameritrade have IRA margin accounts that can be used to avoid free riding violations, but I have not verified that.  IRA account holders using margin would probably be subject to the pattern day trader rules that require $25K in capital for accounts that trade often on margin, otherwise IRAs should look like cash accounts that aren’t subject to this rule.

The tax treatment of trades in IRAs is pretty simple—in the short term you don’t pay taxes on profits from individual trades, and you won’t be able to take a deduction for any losses.  In a tax deferred account like a traditional IRA you’ll generally pay taxes on your gains when you make distributions, but in the meantime you’re compounding your money without paying taxes, which is a huge advantage.  Of course taxes are a horrendously complicated subject, so consult your tax adviser for definitive answers.

 

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Tuesday, April 21st, 2015 | Vance Harwood
  • Vladimir Menkov

    Looking at Pub 590, I reckon that the particular IRC prohibition which prohibits customers from buying on marging in an IRA is not the prohibition on “Borrowing money from it”, but rather the prohibition on “Using it as security for a loan”.

  • Hi Vladimir, I think you’re right. I’ve updated the post to reflect your suggestion.

    — Vance

  • Darin

    Vance,

    It’s been a while since you wrote this, but did you check the other brokers besides Interactive and TD Ameritrade to see if you can have a Margin in brokerage? Thanks