IRA’s, private retirement accounts given special tax treatment as a matter of US policy, are central to many investors' portfolios. These accounts offer huge benefits to traders, as they allow you to either defer (regular IRA) or avoid (Roth IRA) taxes on dividends and profits. At the most basic level, you just sign up with a broker to begin trading using your IRA. While other retirement accounts, like the 401(k), restrict you to an extremely narrow range of financial products, IRA’s of all types offer a great deal more freedom. This approach does carry some vital limitations, however, of which any investor centering their trading strategy on an IRA should be keenly aware.
Some regulations on IRA trading are brokerage specific, but the most important restrictions on founded on the IRA regulations that are used to set up these accounts in the first place. Most fundamentally, an IRA account cannot be used as collateral for a loan (collateral can be seized in the event of default, after all, and the whole point of the IRA system is to create a safe well of retirement funds). The most immediate upshot for stock investors: IRA accounts cannot be used to “buy on margin,” and add leverage to your stock plays. The mechanics of a short sale also depend on securing the transaction using personal funds and are thus also prohibited from IRA accounts (though you could gain some exposure to the short side of the market using short-focused ETF’s). A few brokerages are exploring extremely limited leverage options for retirement account holders, but these aren’t expected to lift the fundamental constraints discussed above.
In short, IRA’s offer powerful tax advantages but sharply constrain your strategic options. When utilizing a normal, taxable account, the varieties of transaction available are truly amazing. You can short, use margin, explore commodities, trade huge variety of options, and much more. All of these avenues offer more opportunities for profit, but not every investor plans to utilize them.
This decision, then, centers first on the type of trading you’re looking to do. If you’re not interested in shorts, options, or FOREX, there’s likely to be no compelling reason to give up the tax advantages of an IRA. Concurrently, since IRA’s ultimately save you money by letting you move taxable income to retirement (when you’re earning less and thus in a lower bracket), your decision should take into account your current income level. If you’re in a high bracket now, the savings from IRA-based trading could be immense. Finally, we should note that there’s no rule requiring only one stock trading account. You could readily keep core holdings in your IRA while moving other funds to a taxable brokerage account for more opportunistic plays like shorts and options.
One final factor to consider is the body of regulations concerning day trading: accounts that pass a certain level of activity will be labeled as “day trading” accounts and subject to a special requirement for a $25,000 minimum balance. In a traditional account, you could always simply add funds to meet the minimum balance in case of a liquidity crunch. But adding funds on demand isn’t always so simple for IRA’s tied to employment earnings. Even trades that ultimately profit can pull your balance below the minimum because of the lag-time in settling funds from stock transactions. Very active traders will need to be careful managing their settled funds in an IRA.
We’ll continue to explore the fundamentals of profitable stock trading for individual investors in the coming days on our blog. If you’d like to learn about how our platform synthesizes real-time stock data with a vast database of news events to find market-beating profits, we recommend one of our totally free virtual training seminars. Just grab a spot in our next session using the button below: