All the fun of trading, with none of the headache!

If you’ve ever wondered how to go about trading and investing in stocks, yet not having to report it all at the end of the year (think: capital gains, other tax annoyances, etc), then this post today is for you. And it’s completely legal :)

Here’s the quick answer: Invest and trade your stocks inside an IRA.

It could be through a Roth, a Traditional, or even a SEP like I use for all my stock and tax-beneficial purposes (A SEP is an IRA and retirement vehicle for self-employed people, similar to a 401(k). Only it’s tied to your company’s profit and no one matches any of your contributions, *tear*)

Which IRA you use doesn’t matter for this stock stuff we’re talking about here (though of course you DO need to pick the right one to open up in the beginning depending on your situation (ie. a Roth, Trad, etc)), but you do have to tell the place you’re opening it that you *want to trade stocks in it.* They don’t always come with that option so it’s important to mention if/when you do indeed want to do some trading there. I believe the correct term for all this is “self-directed” maybe? That’s what my good buddy calls them down below anyways. And I have heard that used a lot. I just called them “brokerage IRAs” cuz that’s what I told USAA I wanted years ago when opening up my first Roth. They never corrected me so I could be right too ;)

Anyways, once you have this account you can buy and sell stocks in them to your heart’s desire as long as you DON’T PULL THE MONEY OUT of the IRA itself. You can buy up stocks, sell stocks, hold stocks, liquidate to cash and wait until you want to dive in again, whatever you want. Some brokerages even allow option trading (don’t ask me what that is). As long as you don’t pull cash out of the IRA itself and go spending it y0u’re fine. Unless you love getting hit with fees…

Let’s use an example here.

You just heard about the Twitter IPO and you’re all about investing in companies you love. So as soon as you’re able to buy stock in it you max out your “self-directed” Roth IRA and now have $5,500 sitting there pretty, ready to be traded for sexy stocks of Twitter. You buy your two shares (hah!) and now you’re sitting on $5,500 of cold hard Twittery goodness.

6 months goes by and BAM! Your stocks are now worth $20,000! Huzzah!!! You quickly rush to your stock buttons online and hit “Sell! Sell! Sell!” ‘cuz you’re no fool and you’re not gonna repeat the disasters of Facebook, and you now have a liquidated account of $20,000 cash minus the $6.99 it cost you to pull the trigger. You’re up almost $15,500! And now because it’s in your IRA and not a normal brokerage account, you don’t have to pay any capital gains or crazy taxes at the end of the year too. Double Huzzah!

Now what you do after that depends on you, but at some point you’ll want to go stock hunting again. Or maybe mutual fund, index fund hunting – depending on how risky you’re still feeling ;) You can invest in whatever you want with these types of “self-directed” accounts – not just stocks. And as long as you don’t pull the money OUT of your new fancy pants IRA, you can continue your success for years and years until you’re old and gray and it’s time to cash out in retirement.

It’s THEN that you pony up for any taxes owed depending on your situation at the time and what type of IRA you were playing with (for example, with Traditionals it’s all pre-taxed money so you’ll owe a lot, where as with Roth’s you’re using after-tax money initially and has all been growing tax-free). So you’ve essentially skipped 50 years of reconciling stock sales and only worry about your taxes when it’s time to enjoy the “good life” :) Not that you’ll have to reconcile any stock trades then btw, it’ll all be based on the total amounts in there I believe.

PS: Before continuing I should note here that I am *NOT* a tax/financial professional. Double check everything I’m saying with smarter people before you pull any triggers  ;)

Okay now, did all that I just said make sense? I think I hit everything right there. Pretty much it all comes down to how  accessible you want this stock money to be, and how much you’re legally able to contribute to an IRA when it’s time to stock dive. If you don’t make millions of dollars and have hundreds of thousands laying around to be invested in individual stocks, like me, this may be a smart move for you :) I don’t know why anyone with millions laying around would even be READING this blog anyways, though. Haha…

So, to recap – the PROS of trading stocks in IRAs:

  • No messing with tax-related stock reconciling at the end of the year
  • No temptation to cash out and blow all your earnings on something stupid.

And the cons of trading stocks in IRAs (I thought of some more while typing this):

  • You might make too much money to even be *able* to invest into an IRA (at least a Roth one)
  • You might act riskier in your retirement accounts having access to stocks vs. without.
  • You can’t write off any losses (I think I have that correct? I’ve never needed to do this…)
  • You can’t cash out all your stocks and go blow it on something fun and stupid ;)

There are more details to be paid attention too of course (again, check with someone smarter before jumping in here), but in a nutshell that’s the deal. I’ve been doing this personally for almost 10 years now and it’s made my life easy peasy lemon squeezy.

I’ll leave you with an email a good friend of mine sent me yesterday which prompted all this:

I’ve recently been more active with my self-directed IRA. Buying/selling stock without having to worry about capital gains tax (especially for short-term gains).
Come next April, I don’t have to do anything on taxes because it’s non-reportable stuff. All the fun of trading, with none of the headache!

I don’t know why I didn’t do this 10 years ago, man.

You learn something every day!

—————
Photo/Art by petesimon

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27 Comments

  1. Brian September 17, 2013 at 10:28 AM

    Well there is something to this, but if you are investing in long term growth style stocks, then investing a taxable account is often better because you would only be taxed at the capital gains rate versus the ordinary income rate (assuming you aren’t doing this in a ROTH). If you invest in dividend paying stocks (qualified dividends) in a taxable account, these can sometimes be “tax free” too since the tax rate on dividends is the long term capital gains rate and is based upon your income level.

    Reply
    1. J. Money September 17, 2013 at 6:23 PM

      That’s a little above my head, but I’m glad you put it out there for everyone else to see and keep in mind :) Thanks man.

      Reply
  2. Stephanie September 17, 2013 at 10:52 AM

    I’m pretty sure your first “Con” is moot – the contribution limits only apply to what you’re putting in, not if you’re liquidating funds and reinvesting them. So, if I put in the IRA max ($5,500 for 2013) in a year, and then halfway through I liquidated funds and reinvested it, I’m not going to have a penalty for over contributing because of growth. As far as I understand, once it’s in, it’s in and the growth has no bearing on your contribution limits. I’m reasonably certain on this (as someone who works in the financial industry but isn’t a tax professional), but maybe someone else could confirm.

    Reply
    1. J. Money September 17, 2013 at 6:30 PM

      Totally! You’re right – once that money’s in there it’s in there and you can trade/sell/buy/whatever you want with it inside the account. I meant more that if you make a ton of money you won’t even be *able* to invest into a Roth to begin with. For example, if you’re “single, head of household, or married filing separately and you did not live with your spouse at any time during the year” and make over $127,000 as your “modified AGI”, you wouldn’t be able to put any money into a ROTH IRA for that year.

      I should probably go clarify that on the post now – good catch :)

      Reply
  3. KM September 17, 2013 at 11:15 AM

    My company offers this option in our 401(k) (I think it’s called the “brokerage” service), but you have to pay a fee (I think maybe $40…can’t remember exactly, but it seemed high when I first read about it) every time you buy or sell so you don’t exactly want to be using this service on a weekly basis.

    Reply
    1. J. Money September 17, 2013 at 6:31 PM

      Yikes – a $40 fee could certainly change things depending on how it’s calculated (per month? per trade? per year?)

      Reply
  4. Debt Blag September 17, 2013 at 12:11 PM

    I thought this was going to be some link to a stock simulation, but this turned out much more interesting :)

    You’re very right. I think lots of people have an incorrectly limited idea of what’s allowed in an IRA and I’m glad you touch on that. So far as I know, the only things you can’t put in are collectibles (except for some federally issued coins…to the extent that those are considered “collectibles”) and cash value life insurance.

    Want to be adventurous and do individual stocks or even stock options or foreign real estate? That’s legal. Want to be super-conservative and just buy CDs or stick your IRA in a savings account? Also legal.

    Great post :)

    Reply
    1. Brian September 17, 2013 at 12:53 PM

      You are right about the coins. They pretty much only allow bullion in them and you have to have a third party store them for you. You would be much better buying these and storing them yourself. Plus, it is much harder for the government to track your transactions then (if you are the paranoid type or the tax evading type for capital gains, which are taxed at the “collectibles” rate).

      Reply
      1. J. Money September 17, 2013 at 6:33 PM

        Woahhhh really??? I didn’t know you could invest in bullion like that into them!!! And I’m glad I didn’t know that either all these years! Haha… I would have def. been tempted to do so and lost a ton in the process ;)

        Reply
        1. Debt Blag September 18, 2013 at 9:41 AM

          Ha. That’s right. There are truly very few limits as to what can qualify as assets in a retirement account :)

          Maybe I need to do a post about this…

          Reply
          1. J. Money September 18, 2013 at 8:03 PM

            I think you do!

            Reply
  5. Tiffany September 17, 2013 at 12:29 PM

    Thanks J. Definitely something that has crossed my mind but I haven’t actively pursued as of yet. I’ve had a brokerage account for almost a year now, just part of my *play* money but have decided that it’s best (and more responsible) to slowly liquidate and then put it toward paying down my mortgage. I have an IRA with a bit in it, so I’m glad to know it’s something you can do… cause I am having lots of fun, hehe! And given that I have quite a large time horizon and my trading behavior so far, I’m reasonably confident that I won’t panic sell and mess up all my hard work. I’ll definitely run this by my money people but it was for sure a timely post for me :-)

    Reply
    1. J. Money September 17, 2013 at 6:34 PM

      Coolness :) Yeah if you’re trading/saving up for a down payment on a house, prob. best to stick with what you’re doing since the money is a lot more liquid there. Don’t want to be messing around with your retirement accounts and make any costly mistakes if you don’t have to.

      Reply
  6. Brian September 17, 2013 at 12:45 PM

    Great post. I didn’t realize this could be done within an IRA. Something to look forward to when I kick up the retirement savings. .

    Reply
  7. John S @ Frugal Rules September 17, 2013 at 1:39 PM

    Good post J$! This is something I encouraged people to do quite frequently in a previous life before working for myself. That’s the beauty of the IRA, you can trade as much as you want and not have to worry about the taxation issue for that year. In terms of losses, you’re correct, you can’t write them off that year. I am not certain how it all works out when it comes time to take the money out come retirement time though. As long as you’re not doing crazy trading and racking up fees, then I say go for it. I do it myself and really can save you some headaches.

    Reply
    1. J. Money September 17, 2013 at 6:35 PM

      That’s a good point about the fees – they’ll def. add up if you trade all willy nilly like. Probably something you shouldn’t be doing anyways whether inside a retirement account or not :)

      Reply
  8. SavvyFinancialLatina September 17, 2013 at 3:05 PM

    Great post. I think we’re going to stick with index funds for the first 2 or 3 years. Maybe invest $1000 in some stocks, but index funds are more passive.

    Reply
    1. J. Money September 17, 2013 at 6:36 PM

      For sure. Most people say that’s the best & safest route too :)

      Reply
  9. Christine @ ThePursuitofGreen September 17, 2013 at 4:44 PM

    Sounds like a good option for trading stocks. Still risky, but if you’re into it seems like it could work. I think I’ll stick to mutual funds:p I don’t think I can stand the pressure and suspense of stock trading!

    Reply
    1. J. Money September 17, 2013 at 6:36 PM

      You know yourself well :)

      Reply
  10. jestjack September 17, 2013 at 8:10 PM

    My biggest fear///real or imagined? In need of funds our elected officials decide “with a stroke of a pen” that all these retirement accounts …IRA’s etc are now taxable. The reasoning …the goverment is broke and needs the money. It coiuld happen….not so long ago Social Security benefits were not taxable…now they are.

    Reply
    1. J. Money September 18, 2013 at 8:03 PM

      I believe it. Though I choose to ignore it ;)

      Reply
  11. stephanie September 17, 2013 at 9:52 PM

    2 shares of Twitter=my best laugh of the day. I live here north of fabled Silicon Valley and some days the stocks change so much I don’t even want to hear the news! For those of you already investing I say cheers to you! I am nowhere near being interested right now. Perhaps in 2014, once I see my new salary (*promotion on the horizon* so happy flipping excited!). I’m edging more toward maxing my 403b, ’cause there’s going to be some kind of match and I don’t care if it’s 3%, as it’s been, it’s free cash! (Actually, I wish it were dollar-for-dollar but that’s never gonna happen!!!).
    I do know a good investment dude though. May be time to pay him a visit and ask his very valuable and valued advice!
    Great post J$$$. Got me thinking AGAIN.

    Reply
    1. J. Money September 18, 2013 at 8:04 PM

      Glad you liked it! And very smart on maxing your 403b first – I’d recommend the same :)

      Reply
  12. Jacob | iHeartBudgets September 17, 2013 at 11:54 PM

    Just setup my brokerage IRA in Vanguard. Too scared to play with the funds just yet (don’t have much in there), but want to mess with it once I get some more cash for the ol’ Roth.

    Reply
    1. J. Money September 18, 2013 at 8:05 PM

      Nice! Was it a random coincidence, or was it cuz you saw this post?

      Reply

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