IRA Tax Ramifications--Should You Use Your IRA for Trading?

By: Clay Wyatt

An IRA can be a great tool for building retirement savings. It's tax-deferred status allows for money to be added to the account that would have otherwise gone to Uncle Sam. However, with a plethora of IRA tax rules, you may be wondering if you should use your IRA for short-term trading. Let's take a look at the nuts and bolts of what will happen if you use your IRA for trading.

Trading time frame

Federal Reserve Regulation T requires payment for trades in an IRA within 3 days. Existing cash within the account must be used to pay for the trade, not stocks. Basically, money that is sitting in a money market or other cash account or cash that you deposit into the account must be used to pay for each trade if you use your IRA for trading. With this in mind, you'll have to be sure that you have enough cash in the account, not just enough value to cover the fees. Otherwise, your account will be restricted for 90 days.

Deposit Limitations

If you decide to use your IRA for day trading and intend to cover some or all of your fees with deposits, you must make sure that the deposits do not go over the contribution limit for that year. For those who will be under age 50 at the end of 2011, the limit is $5,000. If you own other IRA accounts, such as a Roth IRA, this is a combined maximum, so you'll have to make sure that your total contributions do not go over $5,000.

The limit for those who are 50 or older before the end of 2011 is $6,000. The same rules will apply in 2012. Make sure that you have not reached your maximum contribution amount for the current year before you decide to use your IRA for day trading - especially if you plan to pay for the trades with deposits.

If you want to get more money into your IRA for trading and the favorable IRA tax benefit described below, roll over money from a 401k or other tax sheltered plans into the IRA.
IRA Tax Implications

If you use your IRA for trading, you won't pay taxes on any gains or losses. This is great if you have gains. However, if you suffer losses because you use your IRA for trading, you will rarely be able to claim them as such. So, you probably won't benefit from reporting a loss on your taxes, even though you actually suffered them.

However, since you trade short term to make profit, the IRA is a great place to do it. You pay no taxes on profits today and will pay ordinary income taxes later. Rather than using your on-IRA funds for short term trading, use them for buy-and-hold stocks on which you pay a maximum 15% tax (same low rate applies to qualified dividends on common stocks). By restricting short term trading to your IRA and using non-IRA funds for those securities and holding periods taxed at favorable rates, you reduce your lifetime total tax.

Conclusion

If you wish to trade, an IRA or tax sheltered account is a great place it do it as it allows more favorable use of your non-IRA funds for securities taxed at lower rates.