Roth IRA: A guide to investing and trading (2024)

Key points

• A Roth IRA allows you to contribute after-tax dollars and enjoy tax-free growth and withdrawals.
• The IRS imposes income restrictions and contribution limits on Roth IRAs.
• Actively trading in a Roth IRA may not be the best strategy for maximizing long-term returns.

The Roth individual retirement account is considered one of the best retirement savings vehicles because it offers tax-free withdrawals in retirement. This can be a huge asset for retirees trying to manage their taxable income.

But to maximize the tax-free growth of a Roth IRA, you must invest wisely. The more your investments grow, the more money you’ll have that the IRS doesn’t take a bite out of.

You must start with an understanding of how Roth IRAs work. After learning the basics, you can create the optimal investment strategy for your account.

Roth IRA basics

Roth IRAs are funded with after-tax dollars. While you don’t get a tax deduction in the year you contribute, your money grows tax-free. Withdrawals are tax- and penalty-free once you reach age 59½ and your account has been open for five years.

Note: You can always withdraw your original Roth IRA contributions without incurring taxes or penalties.

This tax-free growth makes the Roth IRA a powerful retirement savings vehicle. But there are drawbacks, including contribution limits and income restrictions.

You can contribute up to $7,000 to a Roth IRA in 2024, or $8,000 if you’re 50 or older. But not everyone can contribute the maximum amount to a Roth IRA.

That’s because the IRS also imposes income restrictions on Roth IRAs:

• If your modified adjusted gross income is between $146,000 and $160,999 as a single filer or between $230,000 and $239,999 as a married joint filer in 2024, you can contribute a reduced amount to a Roth IRA.
• If your modified adjusted gross income is $161,000 or more as a single filer or $240,000 or more as a married joint filer in 2024, you cannot contribute to a Roth IRA.

How to invest in a Roth IRA

To invest in a Roth IRA, you must first open an account with a financial firm. The process is usually simple and can often be accomplished online in minutes. Once your account is open and funded, you can start investing in your Roth IRA.

What you can invest in

You can invest in almost any financial product within a Roth IRA, including:

• Stocks.
• Bonds.
• Mutual funds.
• Exchange-traded funds.
• Real estate investment trusts.
• Annuities.
• Options.
• Futures.

But remember that financial institutions can place their own restrictions on Roth IRA investments. If you want to invest in assets that many financial firms do not allow, you may need to open a self-directed Roth IRA.

You can invest in the following alternative assets within a self-directed Roth IRA:

• Cryptocurrency.
• Precious metals and other commodities.
• Private placement securities.
• Promissory notes.
• Real estate.
• Tax lien certificates.

What you can’t invest in

The IRS prohibits investing in collectibles or life insurance within a Roth IRA. Collectibles you cannot hold in a Roth IRA include:

• Alcoholic beverages.
• Antiques.
• Artwork.
• Coins.
• Gems.
• Metals, with exceptions for some kinds of bullion.
• Stamps.

How to actively trade in a Roth IRA

Because money in a Roth IRA isn’t taxed, you can trade without worrying about capital gains taxes, said Kelly Gilbert, fiduciary investment advisor at EFG Financial.

But just because you can actively trade in a Roth IRA doesn’t mean you should.

“When it comes to active trading, seek someone with experience for suggestions and advice, as it can and will be very difficult for a beginner,” said Michael Arvay, founder and CEO of Marvelous Retirement Planners.

A 2020 study of nearly 1,600 day traders in Brazil found that 97% of investors who day traded for more than 300 days lost money. Other studies from around the world have resulted in similar findings. So if you want to day trade, it’s best not to risk your entire retirement nest egg.

If you decide to actively trade in your Roth IRA, you can treat it like you would a brokerage account, provided you abide by the IRS’s income and contribution limits and the financial firm’s investment restrictions.

What are options?

Some firms let you trade options within your Roth IRA. Options are derivatives, meaning they derive their value from an underlying asset, often a stock, an ETF or an index.

There are two types of options:

1. A put option gives the holder the right to sell the underlying asset at a predetermined price by a specific date.
2. A call option gives the holder the right to buy the underlying asset at a predetermined price by a specific date.

The person who sells an option is called the writer. They accept the obligation to buy or sell the underlying asset if the holder exercises their right.

You can use options to hedge other positions in your portfolio. For example, you can buy put options on a stock or fund in your portfolio to lock in a minimum sale price. Alternatively, you can use a covered call strategy by writing call options on securities you own to get extra income from the option premium, or purchase price. But remember that you may be forced to part with your underlying assets in the future if the holder exercises the option.

Options can also increase your leverage, allowing you to gain exposure to a large number of shares for a minimal price — the option premium. This means you have the potential for significant gains but also the risk of significant losses.

While options can be effective, you should trade them only if you have investing experience and understand the risks.

Roth IRA restrictions to consider when trading

“Roth IRAs are traditionally meant for building tax-free wealth in retirement,” Arvay said. For this reason, the IRS limits your trading strategies.

You cannot use assets within your Roth IRA as security for a loan. This means trading on margin, where your brokerage firm lends you money to buy securities with your existing account assets as collateral, is prohibited in Roth IRAs.

Note: Some brokerage firms offer access to limited margin within Roth IRAs.

You also don’t have the ability to write off losses incurred within a Roth IRA on an annual basis. So tax-loss harvesting isn’t an option.

“Finally, when it comes to restrictions to trading in a Roth IRA, be very aware of being nickeled-and-dimed in fees,” Arvay said. “Look for low-cost or no-fee/no-commission areas for your money.”

Roth IRA vs. brokerage account: Which is better?

Both Roth IRAs and brokerage accounts offer advantages and can play important roles in your portfolio.

“There is no problem with having both,” said Lori Gross, financial and investment advisor at Outlook Financial Center.

But if you are trying to decide between the accounts, Gross suggested thinking about your objective for the money: “Are you saving for retirement, or are you saving for a specific goal?”

Assuming you don’t exceed the income limits, a Roth IRA is usually the way to go to save for retirement. Its perks of tax-free growth and tax-free withdrawals in retirement are hard to beat.

A brokerage account is often the better choice for short-term goals. You can contribute as much as you want and withdraw your money anytime.

But remember that you must pay taxes each year on earnings within a brokerage account. This isn’t the case with a Roth IRA.

“If you are actively trading, the Roth has the clear advantage of no capital gains, dividend or interest taxation concerns,” Gilbert said. But take care when gambling your retirement savings.

There is no definitive answer to the question of whether a Roth IRA or brokerage account is better.

“I’m very firm on my love for Roth IRAs for my future. But I have a brokerage account too,” Arvay said, adding that you should seek guidance from a financial professional before investing in either account.

Frequently asked questions (FAQs)