If you are reading this you probably already know that Roth IRAs are great investment vehicles and that you can use them to trade stocks. What you might not know is that there is special rules when trading stocks using your Roth IRA.
The benefits and rules of trading stocks using your IRA account are important trade offs to consider.
Knowing the rules is important to avoid getting into trouble as well as making sure you don’t lose your valuable returns as a result of paying fines.
Because of this learning the rules of trading are well worth the effort.
What is Roth IRA Trading?
Trading with your Roth IRA is a lot like the way you would trade using traditional stocks. The main difference as I mentioned earlier is that your returns are tax free so you can reinvest all your profits. For example, if your investment grows from $3000 to $3500 in the first few months, you can reinvest that $500.
Trading stocks with your IRA is a good addition to traditional IRA investments like mutual funds. It also has the potential for higher returns if you do it right.
What are the Roth IRA Trading Rules?
Now that you know what IRA stock trading is all about, let’s cover some of the trading rules for for Roth IRA:
- No margin accounts. A drawback with Roth IRAs is that you cannot invest on margin. A margin account is a type of brokerage account in which you borrow investments from brokerages to buy securities and gain interest. However, because the contributions to a Roth IRA must only be tax-deducted income, your account cannot be a margin account. This also means that you cannot do day-trading (buy and sell stocks on the same day) with your Roth IRA.
- No short-sell stocks. Making use of short-sell stocks is an investment strategy in which you borrow stocks from a brokerage, betting that the price for the stocks will decline. Once the price does decline, you make a profit by buying the stocks from the brokerage at a lower price. However, you cannot short-sell stocks according to the Roth IRA stock trading rules because you need a margin account for borrowing the stocks from a brokerage.
- Limited trading options. Apart from Roth IRA stock trading (that is subject to the restrictions mentioned above), you can also carry out trade with mutual funds and exchange-traded funds. However, there are not many other options available. Moreover, you can never actively trade mutual funds because you are only a contributor to these funds. However, you can trade exchange-traded funds (ETFs) more frequently and actively.
The rules above highlight what you can and cannot do when trading stocks in your Roth IRA account. While there are restrictions and limitations what still makes trading with Roth IRA appealing is that you don’t have to worry about the taxes, that upside might more than make up for the complexity of keeping with these rules.
What are the Drawbacks of Trading?
Aside from the restrictions I already mentioned there are other things to consider that apply to IRA in general that limit how much you can make as well as how and when you can use the money you make.
- Annual limit. Keep in mind that stock trading is still stock trading, it’s not always going to be profitable. You will encounter losses in trade, and that is normal. The problem here though is that Roth IRA contributions have an annual limit of $5,500. This means that if you have already contributed to this limit, you may not contribute more money, despite having lost a large sum of money in trade. This prevents you from actively trading from your Roth IRA account.
- Restrictions on withdrawals. The primary goal for most people when trading stocks is to earn money more quickly. With Roth IRAs though, you cannot withdraw the money from your account unless you are 59 ½ years old. In most cases, long-term Roth IRA investments turn out to be more profitable than trading because of the lesser risk involved.
At the end of the day just like any investment there are multiple factors to consider when doing any investment and that includes deciding on how to invest your Roth IRA. You should never rely on a single investment and you should always do your homework to make sure you stay profitable and within the law. It is up to you to weigh all the factors and determine what's best for you.
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