Short term vs. Long term investing

[Norbert]

I wanted to join the contest and asked my broker about setting up the account. He replied by saying, "The IRS doesn’t allow options in any IRAs Roth or traditional. The only strategy they allow is covered call writing." Is he wrong?

Would be news to me. I'd think the restriction is imposed by the brokerage, and some brokerages give different levels with different permissions to different customers, depending mostly on experience. Another factor may be whether you have a "cash" or a "margin" account.

EDIT: However I think there are certain specific option trading types not allowed in any IRA, such as *un*covered call writing, for example.

 

[sleepyhead]

I wanted to join the contest and asked my broker about setting up the account. He replied by saying, "The IRS doesn’t allow options in any IRAs Roth or traditional. The only strategy they allow is covered call writing." Is he wrong?

Yes, he is wrong. The restriction is put in place by your broker and not the IRS.

 

[clmason]

Yes, he is wrong. The restriction is put in place by your broker and not the IRS.

Thanks, he is going to double check for me.

 

[mitch672]

I wanted to join the contest and asked my broker about setting up the account. He replied by saying, "The IRS doesn’t allow options in any IRAs Roth or traditional. The only strategy they allow is covered call writing." Is he wrong?

I have been buying/selling TSLA, covered calls, and various other options in my Fidelity IRA account for years.
you need to apply for approval, but once they approve you, there is no problem.
The bonus of trading in an IRA account is, you don't have to pay taxes on your trading profits.
They get you on the 'way out' as you withdraw the money, with ordinary income tax as you start withdrawing it at age 59 1/2 (minimum)

 

[Discoducky]

I wanted to join the contest and asked my broker about setting up the account. He replied by saying, "The IRS doesn’t allow options in any IRAs Roth or traditional. The only strategy they allow is covered call writing." Is he wrong?

Yes, he is wrong. The restriction is put in place by your broker and not the IRS.

Yep, my traditional IRA that I setup recently, in eTrade, allows for Level 1-3 options trading

 

[Norbert]

They get you on the 'way out' as you withdraw the money, with ordinary income tax as you start withdrawing it at age 59 1/2 (minimum)

Unless you convert it to a "Roth" IRA, in which case you pay the taxes when converting (or you contribute with after-tax money). Converting a traditional IRA account to a Roth IRA is a way to increase the effective amount in the account.

 

[dha]

I'm considering joining this Roth IRA challenge and have a question for any tax experts here (I'm looking at you, sleepy).


Let's say I contribute $5.5K to a Roth this year and no more. I make some amazing trades, win this challenge and my account is worth $1 million after 5 years.


I want to withdraw all this money in order to buy a fully-loaded Model S and X for each member of my family. Since I will still be much younger than 59 years old, I will be subject to taxes at my marginal rate and also face a 10% early withdrawal penalty.


Let's say I want to avoid taxes. Can I quit my job in the prior year, and therefore earn less than $9075 (10% federal bracket) in salary and wages? Then, will I be able to withdraw all the money from the Roth and face only 10% taxes and 10% penalty, and enjoy 800K tax free? Or, does the $1 million bump up my federal tax bracket on its own?


I know I should ask my mom's CPA about this directly but I was hoping for a quick answer for now.

 

[austinEV]

I'm considering joining this Roth IRA challenge and have a question for any tax experts here (I'm looking at you, sleepy).


Let's say I contribute $5.5K to a Roth this year and no more. I make some amazing trades, win this challenge and my account is worth $1 million after 5 years.


I want to withdraw all this money in order to buy a fully-loaded Model S and X for each member of my family. Since I will still be much younger than 59 years old, I will be subject to taxes at my marginal rate and also face a 10% early withdrawal penalty.


Let's say I want to avoid taxes. Can I quit my job in the prior year, and therefore earn less than $9075 (10% federal bracket) in salary and wages? Then, will I be able to withdraw all the money from the Roth and face only 10% taxes and 10% penalty, and enjoy 800K tax free? Or, does the $1 million bump up my federal tax bracket on its own?


I know I should ask my mom's CPA about this directly but I was hoping for a quick answer for now.

Whatever you withdraw would be your income. So you would have an income of $1,000,000 and pay the top marginal rate for most of it +10%. But, you would be able to keep about half. Since this is $500k you didn't have before you could just be sanguine about it.

Another option is to set up a "substantially equal payment" plan from the account where you take an even amount from it that you cannot change until you are 59 1/2 and avoid the penalty.

Come to think of it, why the contest requirment that it be an IRA? Why not allow a cash account of $5500, no margin allowed? Edit: to answer my own question because we would be forced to pay marginal tax rate on a cash account for that million without any option.

 

[vgrinshpun]

I wanted to join the contest and asked my broker about setting up the account. He replied by saying, "The IRS doesn’t allow options in any IRAs Roth or traditional. The only strategy they allow is covered call writing." Is he wrong?

It is my understanding that option trading in an IRA is limited because a lot of option strategies require utilization of margin which is not allowed in an IRA account. This is my main concern with setting the competition using IRAs. I would prefer that competition is based on regular brokerage account, not an IRA, as IRA will exclude strategies that use margin.

The idea of competition, however, is brilliant.

I would suggest an informal conference organized by and for the participants at the conclusion of the competition. The winner could be bound by the rules to conduct couple of detailed seminars on the strategy he/she used, with trade examples, etc, followed by the Q/A session. In exchange for this valuable insight, and to honor the winner, his/her transportation and hotel expenses for the conference could be picked up and shared by other participants.

 

[772]

Come to think of it, why the contest requirment that it be an IRA? Why not allow a cash account of $5500, no margin allowed?

For the tax-deferment, I think. If you had a non-retirement account, you may need to withdraw some of that money to pay taxes on your gains. Also, some brokers allow pseudo-margin capabilities on IRAs, too. That is to say, your account can't borrow money, but you can circumvent the day trading and free-rider restrictions on a cash account.

 

[vgrinshpun]

Come to think of it, why the contest requirment that it be an IRA? Why not allow a cash account of $5500, no margin allowed?

I would vote against margin limitation, as my strategy is based on using margin.

 

[772]

We could have 2 categories... IRA and non-IRA.

 

[sleepyhead]

I'm considering joining this Roth IRA challenge and have a question for any tax experts here (I'm looking at you, sleepy).


Let's say I contribute $5.5K to a Roth this year and no more. I make some amazing trades, win this challenge and my account is worth $1 million after 5 years.


I want to withdraw all this money in order to buy a fully-loaded Model S and X for each member of my family. Since I will still be much younger than 59 years old, I will be subject to taxes at my marginal rate and also face a 10% early withdrawal penalty.


Let's say I want to avoid taxes. Can I quit my job in the prior year, and therefore earn less than $9075 (10% federal bracket) in salary and wages? Then, will I be able to withdraw all the money from the Roth and face only 10% taxes and 10% penalty, and enjoy 800K tax free? Or, does the $1 million bump up my federal tax bracket on its own?


I know I should ask my mom's CPA about this directly but I was hoping for a quick answer for now.

For Roth IRA's only, there are some special rules: e.g. if you put something into it, you can pull that something out tax free after 5 years. So if you put in 5500 today and grow it to $1m then you can pull out $5500 5 years from today without any tax consequences. The other gain is always taxable if you pull it out early before retirement age.

On the other hand, as AustinEV stated, you can set up substantially equal periodic payments that can't change until you are 59 1/2. Catch here is if some investments go south and you can't keep paying yourself then you are screwed and might face back taxes.

And your tax liability is always based on how much you make from any source. So if you quit your job and pull out $1m, it will be taxed exactly the same as if you earned that money plus a 10% penalty. If you pull out $10k per year, then you will only pay 10% penalty. If you pull out $100k, then your first 10k is tax free, next X amount is at 10%, then y minus x is at 15%, etc. You cannot avoid taxes. If you work and make $200k and pull out $800k then you will be taxed almost exactly the same had you simply pulled out the whole $1m without working; except now there is a 3.8% medicare tax you might be liable for.

- - - Updated - - -

I think that we should stay with a IRA or Roth IRA, because if you use a personal investment account then you will be subject to taxes. So if you make $900k by the end of the year, you might have to pay $400k in taxes.

There really is no other option than to do it with retirement accounts.

 

[Norbert]

Come to think of it, why the contest requirment that it be an IRA? Why not allow a cash account of $5500, no margin allowed? Edit: to answer my own question because we would be forced to pay marginal tax rate on a cash account for that million without any option.

An IRA account which is a margin account still allows you to avoid waiting for "settlement" of sold stocks. So that's different than both a non-IRA cash account and a non-IRA margin account. Three different things.

 

[DaveT]

A couple quick notes on why I proposed an IRA (or for foreigners it would be a similar tax-deferred account) as a requirement.

First, as some people mentioned already in a tax-deferred account you would be required to pay taxes on all gains. The short-term capital gains taxes would eat up a lot of the yearly gains and it would make it much more difficult to reach $1 million. Not only that, each person would pay a different short-term capital gains tax (based on income tax bracket) and so it wouldn't be fair to everyone.

Second, IRA accounts won't let you borrow money. Some will let you use a pseudo-margin feature where you can trade on unsettled funds but you still can't borrow money to purchase anything. So, since most people would be using an IRA, then it doesn't seem fair to let someone use a non-tax-deferred account and use margin. For one, it adds complexity because the person needs to pay taxes (but probably could do so outside the account). Second, it gives an unfair advantage to use margin when others can't. So for the sake of simplicity, I think it makes sense to restrict account types to just tax-deferred accounts.

Third, I like the idea of limited contribution to $5500 max ever to the account since not only is that the maximum IRA contribution (for most people) but also it's a legendary challenge to start with $5500 and not add funds and still be able to reach $1 million.

On a side note, regarding the 5 year period. What do you guys think of it? I arbitrarily wrote 5 years since I think that would be really tough. For one, we might have a recession in the next 5 years and that might wipe most of value of the participating accounts. Also, the longer the time period the easier the challenge becomes. For example if it's 10 years then it becomes much easier (although I admit it's still a difficult challenge). Anyway, I chose 5 years since I'm not sure if any of us can really reach $1 million within that time period. It's kind of like a highly unlikely outcome. If at the end of 5 years, someone has $500k in their account I think we could extend the challenge for another year to see if the person can reach $1 million. That would be fun to watch... or sad if the person blows it all.

 

[dha]

Thanks for the clarification, austinEV and sleepy...makes perfect sense. So it seems like the only gains that are not taxed as income are long-term capital gains in a taxable account.

 

[DaveT]

Regarding Roth vs Traditional IRA for this contest. I would personally recommend a Roth IRA if you have confidence in your trading/investing abilities to grow the account successfully. Since with a Roth IRA, not only are you not taxed on withdrawals after 59 1/2, but also you aren't subject to the mandatory distribution requirements starting 70 1/2 for traditional IRAs. For Traditional IRAs, you are taxed at your income tax rate for all withdrawals vs Roth IRA withdrawals are tax-free (generally speaking, of course this is assuming it's not an early withdrawal accruing a penalty).

However, if you think you'll probably blow it all and end up with zero in the account going after big/elusive trades, then it might make sense to do a Traditional IRA since your contribution would be tax-deductible (generally speaking). For a Roth IRA, you would need to contribute post-tax dollars.

That said, $1 million in a Roth IRA is a traders dream. Or maybe just my dream.

 

[AlMc]

Regarding Roth vs Traditional IRA for this contest. I would personally recommend a Roth IRA if you have confidence in your trading/investing abilities to grow the account successfully. Since with a Roth IRA, not only are you not taxed on withdrawals after 59 1/2, but also you aren't subject to the mandatory distribution requirements starting 70 1/2 for traditional IRAs. For Traditional IRAs, you are taxed at your income tax rate for all withdrawals vs Roth IRA withdrawals are tax-free (generally speaking, of course this is assuming it's not an early withdrawal accruing a penalty).

However, if you think you'll probably blow it all and end up with zero in the account going after big/elusive trades, then it might make sense to do a Traditional IRA since your contribution would be tax-deductible (generally speaking). For a Roth IRA, you would need to contribute post-tax dollars.

That said, $1 million in a Roth IRA is a traders dream. Or maybe just my dream.

DaveT: Am I mistaken? Thought that you could not open a Roth IRA in certain tax brackets. Guess you are assuming for thos that can't you will ask them to roll traditional IRA into ROTH?

 

[austinEV]

I agree now that IRA is the way to go. And we shouldn't be afraid of a recession since we legendary traders would make money on the way down too, right?

 

[mitch672]

Unless you convert it to a "Roth" IRA, in which case you pay the taxes when converting (or you contribute with after-tax money). Converting a traditional IRA account to a Roth IRA is a way to increase the effective amount in the account.

I think it's too late to convert my traditional IRA to a Roth IRA. My TSLA shares are in it, and it's a significant amount.. I'd have to pay tax on it now... I am also significantly older than most of you, I'm 54, I'm considering retiring early next year, probably using the Substantially Equal Payment Plan, so too late for a ROTH conversion at this point. Thanks to my real estate assets and my TSLA investment, I can essentially retire early.
I'll probably play along with the "make a million out of $5500" anyway, why not