The traditional way to set up an IRA is relatively passive. Investors set up their IRA, choose from a predetermined list of stock funds, and hope that they choose the right one. Over time, they might diversify their portfolio with a wider number of funds, or even add other assets, such as bond funds, into their IRA. But a Self-Directed IRA turns that all on its head.
With a Self-Directed IRA, investors can choose all sorts of nontraditional retirement assets that can be held within the account. For example, real estate can be held within a Self-Directed IRA, giving the investor more retirement portfolio exposure to a different type of asset entirely from the stock market. And there are more options: precious metals, tax liens, private notes, even private companies. In fact, the IRS prohibits a few assets by name.
What does that mean for an investor who is looking at something like carrying the highly volatile, aggressive strategy of options trades? First, a definition.
Definition: Just What is “Trading Options,” Anyway?
To trade options with a mainstream broker like a Fidelity or a Charles Schwab, one has to look at the specific rules of these brokers. According to Investopedia, “Fidelity Investments permits the trading of vertical spreads in IRA accounts with only $2,000 set aside as a reserve.” There may also be restricted “margin accounts” permitted by brokers in which investors have to play by the rules of the broker.
Does this mean that an investor can use a Roth IRA for something like active trading? There is a lot of gray area here. According to Investopedia, “Safeguards should be taken so that the options do not seem like a mere speculative tool in these accounts, in order to avoid potential problems with the IRS’ rules and taking on excessive risks for funds slated to finance retirement.”
This means that there is a tremendous amount of freedom within a Self-Directed IRA, but that investors have to be wary of using their retirement accounts in ways that could create problems for them. A retirement account is designed to be a stable way to grow money—it is not intended as a “wild west,” free from taxation, wherein investors can simply move money and act as they please.
That said, it is important to understand the options investors do have when selecting a Self-Directed IRA.
What Investors Need to Know
There are some traits of trading stock options that all investors should know. For example, the basics: trading “on margin” is highly risky and can wipe away a tremendous amount of value for an investor in a very short amount of time. Investors should educate themselves on this style of trading before making any decisions that could be potentially volatile for their retirement accounts.
Margin trading is also difficult to diversify, since it primarily means investors are using their money with leverage, creating the potential for a high-risk, high-reward situation. This leverage is what can suddenly wipe out an account seemingly overnight.
But there are other ways to see aggressive growth within a retirement account while still diversifying one’s assets. For example, a tax lien can create optimum returns in certain states, depending on the local regulations. Real estate in general can also be a high-risk, high-reward asset. The beauty of the Self-Directed IRA is that it lets investors choose—but it’s also the risk that comes with self-direction. Investors should proceed with caution, understand every investment, and do their due diligence before making any specific choices.