One of the advantages of trading stock in an individual retirement account is that you may be able to postpone taxes. In some cases, you can avoid taxes altogether, but stock trading in an IRA isn't always advantageous. Due to the tax structure of IRAs, you may end up paying a higher tax rate on your stock trading than you would if you had kept your stocks in a regular investment account.
An IRA is a tax-advantaged retirement account. Any investment gains you earn in an IRA are not immediately taxable. In the case of most IRAs, your gains are deferred until you take a distribution from the account. For Roth IRAs, your withdrawals are typically tax-free. If you trade stocks rapidly, you could end up generating a large number of short-term gains, which are taxed at ordinary income in a regular investment account. By trading those stocks in an IRA, you can defer or even avoid that tax until you take the money out, typically at retirement.
Taxes on Distribution
With the exception of Roth IRAs, distributions from IRAs are taxable at ordinary income tax rates. This can prove disadvantageous if you are a stock trader, as long-term capital gains generally benefit from a reduced tax rate. If you held your stocks for longer than one year in a regular investment account, your gains would be taxed at the long-term capital gains rate of 15 percent. In an IRA, your distributions will be taxed at your marginal tax rate when you take them, which could be as high as 39.6 percent, as of the time of publication.
If you need the proceeds of your stock trading while you're young, investing in an IRA may cause complications. In addition to taxes, your IRA distributions can trigger an additional 10-percent tax penalty for early withdrawal if you're under age 59 1/2 when you take them. For Roth IRAs, any earnings you withdraw will also become taxable if you're under age 59 1/2, even though most Roth distributions are tax-free. The purpose of the penalty is to encourage you to keep your money in your IRA for its intended use, which is your retirement nest egg.
Most dividend-paying stocks pay quarterly. As a stock trader, you may not be interested in the dividends that many stocks pay out to investors, but if you trade stocks in an IRA you may end up with dividends being paid into it at some point. As with your stock trading profits, your stock dividends are not taxed until you withdraw them from the account, or not taxed at all in the case of qualified distributions from a Roth IRA.
John Csiszar has written thousands of articles on financial services based on his extensive experience in the industry. Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to his online work, he has published five educational books for young adults.