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
Jay loves talking about money, collecting coins, blasting hip-hop, and hanging out with his three beautiful boys. You can check out all of his online projects at jmoney.biz. Thanks for reading the blog!