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IRA Radical
by Chris Verhaegh

Money From Nothing IRA refers to Individual Retirement Account, not the Irish Republican Army. For foreign readers, and any unaware Americans, this is the simplest of self directed retirement savings accounts.

I am not a Tax Professional, nor do I claim to be one. This writing is meant to show you how I look at trading in a retirement account. It is not meant to have you blindly follow in my footsteps. As with anything tax related, consulting an expert remains the prudent action.

In an IRA and a Roth IRA gains grow tax free. Tax implications are a function of when the money was put in or how and when it will be taken out. They key again is the tax free growth. It is my opinion that letting money sit in an IRA wipes out its greatest advantage to a regular investment account.

If a stock is held long-term in a regular account, any gain would not be taxed until the stock is sold. If held long enough, it should fall under the long-term capital gains status and be taxed at a lower rate.

If a stock is held short-term in a regular account, any gain would also not be taxed until the stock is sold. But, if not held long enough, it would fall under the short-term capital gains status and be taxed at a higher rate. The money would be available again and can be traded in the short-term again and again. Each time a position is closed a taxable event occurs. Each time, most likely, would be at the higher short-term tax rate.

If these short-term trades were made in an IRA their gains would not be taxable, hence the advantage to trade short-term in them.

Written in gray ink, IRS code doesn’t tell what can be done, but what can’t. Because of this, many option traders are unaware they can buy options in their IRA. The problem is, finding a broker who will allow it. Most any broker will permit selling Covered Calls in an IRA. The key is to open and/or fund an account before the annual deadline. Transferring the IRA to the right broker can be done later.

Specifically, it is illegal to borrow money in an IRA. The thought being, if you can’t borrow you won’t owe. No debt equals no chance of insolvency. Americans can’t lose more than their entire retirement accounts.

The vast majority of the time, margin refers to borrowing money to buy stock. Hence, you can’t use margin in your IRA. But margin doesn’t always mean borrowing. It also refers to security and maximum risk. Most brokerage firms make no distinction.

Margin as Borrowing: Writing Covered Calls involves buying stock and selling a call against it. Using a margin account cuts in half the money needed to buy the stock, while still pulling in 100% of the option premium. Using margin to borrow can double the return on the investment, but it also risks borrowed money.

Margin as Security: Naked Puts and Covered Calls have the same risk characteristics. Both have a limited reward, while risking the stock going bankrupt. Margin on writing Naked Puts varies broker to broker, typically between 20% - 25%. Since the margin rates are roughly half again of writing Covered Calls, the profit potential may double again. Additional brokers may allow 100% cash secured Naked Puts in retirement accounts, but this lowers the reward ratio of Naked Puts to being equal with non-margined Covered Call writing.

Margin as Maximum Risk: When it comes to trading spreads, margin means the maximum risk. Before allowing a trader to make a spread trade, brokerage firms require margin equal to the maximum risk. In a Bull Put Spread the maximum risk would be the difference between strike prices less any premium collected. The margin can not be borrowed in regular accounts, so there would be no difference in an IRA.

Options Confused with Borrowing: Most brokerages consider buying options as a prelude to buying stock. They feel options are meant to be exercised. Since they consider it as part of a purchase, and not as full payment, they won’t allow buying options in an IRA. But anyone who traded options for any length of time knows the money is in trading options without exercising them. And isn’t that what an IRA is about, increasing one’s long term financial holdings?

Taxes and Trading: I believe people who have money locked into mutual funds are missing one of the best features of an IRA, trading. Money sitting can compound, but compounding without immediate taxation compounds much faster. Successful IRA trading means not paying taxes on each and every gain. No Schedule D.

In a Traditional IRA taxes may have to be paid upon pulling money out. A Roth IRA allows for trading post tax dollars and therefore may not have taxes due upon disbursement. Either account allows for trading without tax consequence to each trade. ASK YOUR TAX PROFESSIONAL for advice on choosing an IRA.

Only for the Young & Experienced

Young and experienced sounds like a contradiction of terms, but follow my logic. This is my opinion and it’s radical. I like to speculate wildly in my IRA, but only with the Government’s money.

Let’s assume a 35% tax bracket. Different State rates may lower or raise this amount, but for the sake of discussion we need some number. At this tax rate, every dollar placed in a traditional IRA saves 35 cents in taxes. So $2,000 placed in an IRA really means placing $1,300 of hard earned money plus an extra $700 that would go to the IRS.

I may invest 65% of the money in more conservative stocks. Stocks to write Covered Calls on, stocks to collect dividends on. By writing Covered Calls I pull in more money than with “watching the grass grow” mutual funds. I still try to buy at dips. I may trade this aggressively compared to most IRA investors, but nowhere near as aggressive as the remaining 35%. I look at the balance as found money. If I lose, it’s like paying taxes to the market. But if I make a big hit, I may retire years or even decades early.

In the past I would try to buy the next DELL or MSFT. At one point in time, both were cheap stocks with uncertain futures. Hundreds of thousands of cheap stocks exist. Experienced investor’s knowledge helps them to distinguish between rocks and rockets. While young people have the resilience to come back if they’re wrong.

Now my thoughts are to trade often in my IRA. Often might mean once or twice a month. Not anything close to “day-trading”, but not “buy & hold” and waste an opportunity.

I’m not worried anyone will confuse the Internal Revenue Service’s three letter abbreviation with a stock ticker symbol. No stock trading on an American exchange will ever have the ticker IRS. If there is anything most people don’t want to give money to, it’s anything remotely associated with the IRS.

 
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