Is Option Trading in an IRA Account Ending?

Retirement Investments
Saving for retirement. Google Images

The United States Department of Labor is getting ready to take action that limits our ability to use options in an IRA account. That is especially galling because options are used to reduce risk. I cannot understand why so many market professionals and government entities fail to understand that one simple fact about options. Too many people believe options are tools that are primarily used by gamblers.

The Employee Retirement Income Security Act (ERISA) requires fiduciaries of pension plans to perform certain due diligence on service providers and plan investments. This helps ensure that the fiduciary is acting in the best interest of the plan's participants. That's good. However, in an effort to limit the ability of these fiduciaries to make unsuitable recommendations, it feels as if the Labor Department is "throwing out the baby with the bath water" by making it extremely difficult for individuals to continue to use options in retirement accounts.

The following letter illustrates how one broker, TDAmeritrade, explains the situation to its customers:

The U.S. Department of Labor (“DOL”) has proposed a new rule that it believes will reduce conflicts of interest between financial professionals/firms and retail investors seeking retirement advice by establishing a strict “best interest” standard applicable when advising certain retirement plans and Individual Retirement Accounts ("IRAs").

The rule takes a very broad view of what “advice” means and imposes very detailed and complex conditions on brokers, like TD Ameritrade, when servicing IRAs. TD Ameritrade does not object to operating in our clients' best interest when we are providing individualized advice. However, these conditions would significantly impact how we communicate with our clients and the investment choices currently available to them in their IRAs.

One such impact is a severe limitation on the ability to trade options and access options-related education in an IRA.

With this rule, many tools, research and information services that were previously viewed as guidance or education would likely be deemed “advice” and subject to the fiduciary “best interest” standard. Without changes to the rule as it currently stands, this means that your account, if considered a broker- advised IRA, would no longer be eligible for options trading.

In order for you to continue to trade options in your IRA under the proposed rule, TD Ameritrade would likely need to significantly limit the support, tools and educational resources its makes available to IRAs so they would not be considered a broker-advised IRA. Or, your account might be converted to a fee-based investment advisory account in which trading options would still be permitted.

The first approach may limit your ability to make informed trading decisions and the latter likely would increase your costs.

This important topic has been widely discussed in the press. For example:

  • The New York Times (April 14, 2015) described the proposed rule changes.
  • This NTY article (Sep 18, 2015) discusses why the rule change is needed and how less-than-sophisticated investors may get some protection from the brokerage industry. I agree that the industry does not treat customers fairly, but there is no reason to prevent a well-educated investor from hedging (reducing risk) with options.