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An IRA account with limited margin is a retirement account that allows investors to trade securities with unsettled cash. It’s a more lenient structure than a cash account, where you must wait for trades to settle before using the money for further trading. But an IRA account with limited margin isn’t a true margin account in that you can’t use leverage.
Nonetheless, an IRA account with limited margin offers a few advantages, including the ability to defer or avoid short-term capital gains tax and protection against good faith violations. That said, there are still restrictions, so before setting one up, it may be beneficial to learn more about how these accounts work.
Key Points
• A limited margin IRA is a type of IRA that allows you to trade with unsettled funds.
• The limited margin works like a cash advance for positions sold, but it doesn’t allow trading with leverage using margin debt.
• Having access to limited margin in your IRA may be an advantageous tax strategy if you intend to day trade.
• Some brokerages have eligibility requirements, such as a minimum equity threshold.
• A limited margin IRA may help you avoid good faith violations if you often have quick turnarounds on your trades because it allows you to use the funds from sales before the sale is settled.
What Is an IRA Account With Limited Margin?
An IRA account that has limited margin, often called simply a limited margin IRA, presents a more flexible option to invest for retirement than a traditional IRA. These types of IRAs may allow you to trade with unsettled funds, meaning that if you close a position, you don’t have to wait the standard two days after you trade. You can use those funds right away.
There may also be tax benefits. In a traditional IRA margin account, capital gains taxes are deferred until funds are withdrawn. This is similar to a regular IRA, where you don’t pay taxes on contributions or gains until you withdraw your money.
You may also be able to use limited margin in a Roth IRA, and there may be even more tax benefits when using limited margin in a Roth IRA. You don’t pay any capital gains because Roth accounts are tax-free since Roth contributions are made with after-tax money.
As noted, an IRA account with limited margin may allow investors to trade with unsettled cash. However, a limited margin IRA is just that: limited. It isn’t a true margin account, and it doesn’t allow you to short stocks or use leverage by borrowing money to trade with margin debits. In that sense, it’s different from margin trading in a taxable brokerage account.
You may be able to use limited margin in several IRA types. In addition to having margin IRAs with traditional and Roth accounts, rollover IRAs, Simplified Employee Pension (SEP) IRAs, and even small business SIMPLE IRAs are eligible for the margin feature. While mutual funds are often owned inside an IRA, there are some types of mutual funds that you can’t buy on margin.
How Does Limited Margin Work?
Limited margin works by allowing investors to trade securities without having to wait for funds to settle. You can think of it like an advance payment from positions recently sold.
The first step is to open an IRA account and request that the IRA margin feature be added. Once approved, you might have to request that your broker move positions from cash to margin within the IRA. This operational task will also set future trades to the margin type.
IRAs with limited margin will state your intraday buying power. You should use this balance when day trading stocks and options in the IRA.
An advantage to trading in limited margin IRAs is that you can avoid or defer capital gains tax. Assuming you earn profits from trading, that can be a major annual savings versus day trading in a taxable brokerage account. If you trade within a pretax account, such as a traditional or rollover IRA, then you simply pay income tax upon the withdrawal of funds. When using Roth IRA margin, your account can grow tax-free.
The drawback to an IRA with limited margin versus day trading in a taxable account is that you’re unable to borrow money from your broker to create margin debits. You’re also unable to sell securities short using an IRA with limited margin. So while it’s a margin account, you don’t have all the bells and whistles of a non-IRA full margin account.
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Who Is Eligible for an IRA With Limited Margin?
Some brokerage firms have strict eligibility requirements, such as a minimum equity threshold (similar to the minimum balances required in full margin accounts). When signing up, you might also be required to indicate that your investment objective is the “most aggressive.” That gives the broker a clue that you will use the account for active trading purposes.
IRA Margin Calls
An advantage to having margin in an IRA is that you can more easily avoid margin calls by not having to wait for cash from the proceeds of a sale to settle, but margin calls can still happen. If the IRA margin equity amount drops below a certain amount required by your broker, then a day trade minimum equity call can be issued. Until you meet the call, you are limited to closing positions only.
To meet the IRA margin call, you just have to deposit more cash or marginable securities. Since it’s an IRA, there are annual contribution limits that you can’t exceed, so adding funds might be tricky.
đź’ˇ Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.
Avoiding Good Faith Violations
A good faith violation happens when you purchase a security in a cash account then sell before paying for the purchase with settled cash. You must wait for the funds to settle — the standard is trade date plus two days (T+1 settlement) for equity securities. Only cash and funds from sale proceeds are considered “settled funds.” Cash accounts and margin accounts have different rules to know about.
A good faith violation can happen in an IRA account without margin. For example, if you buy a stock in the morning, sell it in the afternoon, then use those proceeds to do another round-trip trade before the funds settle, that second sale can trigger a good faith violation. Having margin in an IRA prevents good faith violations in that instance since an IRA with limited margin allows you to trade with unsettled funds.
Pros and Cons of Limited Margin Trading in an IRA
Can IRA accounts have margin? Yes. Can you use margin in a Roth IRA? Yes. Should your IRA have the limited margin feature added? It depends on your preferences. Below are the pros and cons to consider with IRAs with limited margin.
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Pros:
• You’re permitted to trade with unsettled cash.
• You can avoid good faith violations.
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Cons:
• You can’t trade using actual margin (i.e., leverage).
• You can’t engage in short selling or have naked options positions.
• You take on more risk with your retirement money.
The Takeaway
An IRA account with limited margin allows people investing in individual retirement accounts to trade securities a bit more freely than a cash account. The main benefit of having an IRA with limited margin is that you can buy and sell stocks and options without waiting for lengthy settlement periods associated with a non-margin account.
But remember: Unlike a normal margin account, this type doesn’t allow you to use leverage. That means a margin-equipped IRA doesn’t permit margin trading that creates margin debit balances. You’re also not allowed to have naked options positions or engage in selling shares short.
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FAQ
Is an IRA a cash or a margin account?
An IRA can either be a cash account or a limited margin account. While a cash account only lets you buy and sell securities with a traditional settlement period, a limited margin IRA might offer same-day settlement of trades. You’re not allowed to borrow funds or short sell, however.
Is day trading possible in an IRA?
You can day trade in your IRA, and it can actually have tax advantages. The tax liability of short-term capital gains can add up, but because an IRA is tax sheltered, you can buy and sell stocks and options without the same tax consequences of a brokerage account. The downsides are that you can’t take advantage of the $3,000 capital loss tax deduction, you can’t borrow funds to control more capital, and you’re limited to going long shares, not short.
Can a 401(k) be a margin account?
Most 401(k) plans don’t allow participants to have the margin feature. An emerging type of small business 401(k) plan — the solo brokerage 401(k) — allows participants to have a margin feature. Not all providers allow it, and you may not be able to borrow money from the broker to buy securities.
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