What To Know About Trading in a Roth IRA

Can you actively trade in a Roth IRA?

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Roth IRAs are popular retirement accounts that individuals manage on their own. Their appeal is that you can withdraw your contributions in retirement years without paying taxes on them, including on any earnings.

With retirement accounts such as Roth IRAs, most investors aim to invest and hold positions for the long term so contributions and earnings can compound over time. These accounts are designed for buy-and-hold investing. However, some investors use more active trading strategies in their Roth IRAs.

Learn more about how Roth IRA trading works, the pros and cons, and if it’s right for you.

Key Takeaways

  • Roth IRAs are retirement accounts funded with after-tax dollars so that money can grow tax-free.
  • You can trade within your Roth IRA, but retirement accounts are designed for buy-and-hold investing.
  • When making Roth IRA investments, consider selecting assets that earn income or pay dividends to take advantage of the tax-free benefits.
  • More complex and aggressive active trading, day trading, and trade options can be done in a Roth IRA, but there are some restrictions and limitations.

How Roth IRA Trading Works

Roth IRAs offer the opportunity for account holders to invest in many asset types, including mutual funds, stocks, ETFs, bonds, and even more complicated transactions such as trading options. As of 2022, you can contribute up to $6,000 to a Roth IRA each year ($7,000 if you are age 50 or older).

To make Roth investments, however, your modified adjusted gross income must be less than $140,000 if you are a single tax filer, or $208,000 if married filing jointly.

Here is some key terminology to know when learning about Roth IRA trading:

  • Trade: Placing any type of buy or sell order in a brokerage account. Anytime you decide to invest in a new mutual fund or dump a stock that isn’t performing well, for example, is considered a trade.
  • Active trading: More frequent trading to try to time the market and increase gains rapidly.
  • Day trading: An aggressive trading strategy, day trading refers to when people regularly make multiple trades in one day.
  • Options: The right to buy or sell a stock for a set price by a future date.

Roth IRAs are designed to be long-term investment vehicles, which is why the majority of account holders use a more conservative “stay the course” approach, letting their holdings grow and compound over time.

It’s common practice to revisit your portfolio on occasion and make trades that help you stay diversified and improve your earnings potential. That said, active trading, day trading, and trade options are also allowed within a Roth IRA.

More-aggressive styles of investing come with much greater risk, so financial advisors don’t generally recommend using them within a Roth IRA, which is designed for retirement funds.

Common Roth IRA Investments

A Roth IRA does not have many investing limitations, and financial advisors recommend increasing diversity to minimize risk while monitoring your asset allocation. Common investments may include stocks, index funds, target-date funds, and bonds.

That said, when making Roth IRA investment choices, you may want to look for assets that let you leverage the tax-free nature of the account. This can include the following:

High-Growth Stocks

High-growth stocks are stocks that have above-average earnings, allowing investors to potentially earn larger returns. They also tend to be riskier. Choosing high-growth stocks for your Roth IRA may make sense because if they perform well, you won’t have to pay capital gains taxes on the earnings.

Dividend-Paying Stocks

Stocks that pay dividends are attractive to many investors, and they can be valuable assets in a Roth IRA. In other types of accounts, dividends are considered taxable income, but in a Roth IRA, your earnings from dividend-paying stocks are tax-free.

REITs

REITs (Real Estate Investment Trusts) are also good investments for Roth IRAs. They are designed for people who want to invest in real estate without actually buying physical property.

Because they pay dividends, buying dividend stocks for your tax-free Roth can make sense because those profits will not be taxed.

ETFs

ETFs, or exchange-traded funds, can help you diversify your portfolio by offering a selection of stocks, bonds, and securities mirrored on a particular market index. In other words, you get to invest in big-name companies or in a particular industry in a less expensive way than buying individual stocks.

ETFs are similar to mutual funds, but they trade more like stocks since their market prices change throughout the trading day. While there are different types of ETFs, choosing growth, dividend, or income funds for your Roth will let you maximize the tax-free benefits.

Prohibited transactions within a Roth IRA include life insurance and collectibles such as art, antiques, stamps, and classic cars.

Pros and Cons of Actively Trading in a Roth IRA

Pros
  • You don’t have to pay taxes

  • You can potentially improve returns

Cons
  • No access to margin trading

  • Losses can’t be deducted

  • Active trading and trade options are complex

Pros Explained 

  • You don’t have to pay taxes: You invest after-tax dollars into a Roth IRA, so you don’t have to worry about paying any type of tax going forward. That means there is no capital gains tax, and you’ll avoid taxes when you make qualified Roth IRA withdrawals.
  • You can potentially improve returns: Although buy-and-hold investing is a reliable strategy, it’s always wise to revisit your asset allocation and diversify your portfolio on occasion with new trades. You might, for example, want to buy during a down market to earn gains later, or sell an underperforming asset.

Cons Explained 

  • No access to margin trading: Serious traders often use margin trading, meaning they can borrow money from the brokerage firm to make purchases. That option is not available within Roth IRAs. Instead, you’ll have a limited margin basis, which, on the positive side, limits your risk since you won’t be able to borrow against your holdings.
  • Losses can’t be deducted: Trading losses can be written off on your tax returns, but not when those losses happen in an IRA account.
  • Active trading and trade options are complex: You have to have a lot of knowledge and time to research potential assets to be successful at trading. Even then, because the market is unpredictable, you would be taking greater risks with money that you may be relying on for retirement.

Should You Actively Trade in Your Roth IRA?

For the majority of investors, active trading in a Roth IRA likely is not as good as a buy-and-hold strategy with retirement funds because of the increased risk. While some level of trading is required to build a strong Roth IRA portfolio, active trading is an advanced strategy.

When You Should Actively Trade in Your Roth IRA

Active trading is best reserved for advanced traders who have time to research potential trades, and who already have a robust retirement nest egg.

Using a small percentage of your Roth IRA to try to profit on short-term trades could be lucrative, as long as you are fine with potentially losing those investments.

Dollar-Cost Averaging as a Less Risky Alternative

For people looking to improve their holdings, taking a more methodical dollar-cost averaging investment route with Roth IRA trading helps reduce risk.

Dollar-cost averaging is when you have a lump sum of cash you want to invest into specific assets. Instead of buying all at once, you split up the purchases over a period of time to protect against potential price swings.

Frequently Asked Questions (FAQs)

Can you day trade in a Roth IRA?

You can technically day trade in a Roth IRA, but there are some limitations. For starters, you may need to keep $25,000 available in the account. If you lose money and your balance dips below that, you may need to add additional funds—but that could be complicated because Roth IRAs have a yearly contribution limit.

Do stock trading fees apply to a Roth IRA?

Whether you have to pay stock trading fees within your Roth IRA varies by account and brokerage firm. Some Roth IRA accounts allow you to trade certain types of assets without transaction fees, while others may incur a small fee. If you’re planning to trade, consider contacting your custodian to ask about investment fees and other costs.

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Article Sources

  1. IRS. “2021 Publication 590-A.”

  2. eTrade. “Making Trades in an IRA.”

  3. U.S. Securities and Exchange Commission. “Form 1099, Investment Income (Interest and Dividends).”

  4. U.S. Securities and Exchange Commission. “Exchange-Traded Funds (ETFs).”

  5. Fidelity. "Tax-Loss Harvesting: How To Investment Losses Into Money-Saving Tax Breaks."

  6. FINRA. "Stock Trading vs. Buy and Hold.”

  7. U.S. Securities and Exchange Commission. “Margin Rules for Day Trading.”