Individual retirement arrangements offer several tax benefits that make them more advantageous for saving for retirement than regular stock accounts. However, IRAs penalize you for taking money out early, while stock accounts offer the potential for lower long-term capital gains rates. The account that's right for you depends on your investment purposes.
You only pay taxes on your stock gains when you realize the gains by selling the stock. For example, if your stock increases in price by $1,000 but you don't sell, you don't have any taxable income because you didn't realize the gain. However, if you sold it for a $1,000 gain, you'd have $1,000 of taxable income. Money in the IRA account is never taxable as long as you don't withdraw it. For example, if you sell stock in the IRA for a $1,000 gain, you don't report that as taxable income; however, when you take a distribution, you have to report the distribution on your taxes at that time.
You can claim a tax break for stock losses in the year that you realize them. However, you can only use losses to offset your gains plus up to a $3,000 deduction. Any excess must be carried forward to future years. For example, if you have $8,000 in gains and $13,000 in losses, your gains would be completely offset, leaving a $5,000 loss. Since you can only deduct $3,000 annually, you would carry forward the remaining $2,000 to the next year. If you suffer a loss in your IRA, you're generally not going to be able to deduct it. To claim a loss, you must close all of your IRAs of the same type, and the amount you receive must be less than the nondeductible contributions you made to the account. The loss is deductible as a miscellaneous itemized deduction, which means you can only deduct the amount that exceeds 2 percent of your adjusted gross income. For example, if you have a Roth IRA with $50,000 of contributions and losses have brought the value down to $40,000, you could close all your Roth IRAs and claim a $10,000 loss, subject to the 2 percent of adjusted gross income limit. If you haven't made any nondeductible contributions, you can't claim a loss.
Stock sales are taxed as either long-term or short-term capital gains. Long-term capital gains come from sales of stocks you held for more than one year. These are taxed at the lower long-term capital gains rates. Short-term gains come from selling stocks you held for one year or less and are taxed as ordinary income. Distributions from traditional IRAs are taxed at ordinary income rates, regardless of how the money was earned in the IRA. For example, if you fall in the 25 percent tax bracket, your IRA distribution is taxed at 25 percent regardless of the type of gains in the IRA. Qualified Roth IRA distributions aren't taxable because you didn't receive a tax deduction for your contributions.
Selling stock doesn't result in any additional tax penalties if you dispose of the stock before you retire. On the other hand, if you take distributions from your IRA before age 59 1/2, the taxable portion of the distribution is subject to an additional 10-percent tax penalty. For example, if you take a taxable $5,000 distribution from your traditional IRA at age 50, you'll owe not only income taxes, but also a $500 early withdrawal penalty unless you qualify for an exemption.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."