Imagine that you're worried about the economy and as a result, you want to move your individual retirement account (IRA) funds from stocks and into bonds to cash. Will you be taxed for doing that?
The short answer is, if you move money out of stocks and into safer assets such as a money market fund, in your IRA, you won't be taxed immediately on any gains, since it will count as a reallocation or rebalancing to your portfolio. You may, however, be subject to taxation upon withdrawal when you are retired.
Key Takeaways
- You can change your individual retirement account (IRA) holdings from stocks and bonds to cash, and vice versa, without being taxed or penalized.
- The act of switching assets is called portfolio rebalancing.
- There can be fees and costs related to portfolio rebalancing, including transaction fees.
- IRA funds can be taxed if you take early withdrawals, however.
Initial Considerations
You'll incur taxes only if you take the money from your IRA via withdrawals or distributions. There might be transaction fees or other related costs when making allocation changes. These costs will differ from one IRA custodian to another.
If you intend to sell and buy stocks frequently, doing it inside an IRA offers tax advantages. A large profit on a stock you've owned for just a little while gets taxed at the short-term capital gains rate, but if it's inside an IRA, you're off the hook. Instead, you’ll get to avoid paying taxes on profits until you’re older. The downside is that you can't take a tax write-off for bad picks, no matter how big your losses are.
IRA Portfolio Rebalancing
Rebalancing your IRA is the act of switching assets or securities you own (i.e., moving from stocks to cash and vice versa). Rebalancing is not taxable when investments are held in an IRA—but is often taxable when held in a taxable brokerage account.
IRAs are a great way to save on taxes. Traditional IRAs allow for up-front tax deductions, allowing you to defer taxes until making withdrawals during retirement. Roth IRAs allow investors to contribute after-tax dollars in exchange for tax-free distributions during retirement.
IRA Taxes
Although you shouldn’t incur any taxes until you take distributions or withdrawals, there are various fees you might incur. For starters, you can get a penalty fee if you contribute more than the limits. As well, if your IRA earns more than $1,000 in unrelated business taxable income (UBTI), then you must pay taxes on that income.
Meanwhile, you can also be taxed on investments made via self-directed IRAs. These IRAs prohibit investments in collectibles. Investing in these assets will be considered a distribution and subject to a penalty.
If you buy or sell securities in a Roth IRA, you will never be subject to taxation since a Roth has already been funded with after-tax dollars and grows tax-exempt.
IRA Withdrawals
Early withdrawals from your IRA, before age 59½, are not only taxable at ordinary income rates, but will also face a 10% penalty. You can make early withdrawals and still pay ordinary tax rates but avoid the penalty if the money is used for certain purposes. Examples include using the money for first-time home purchases and paying unreimbursed medical expenses.
Meanwhile, there are required minimum distributions (RMDs). Distributions from a traditional IRA, and other certain IRAs, must start when you are 73 if you were born between 1951 and 1959, or 75 if you were born in 1960 or after. If an investor fails to take RMDs, they will be charged a 50% excise tax on the amount required to be taken.
What Types of Investments Are Not Allowed in an IRA?
IRAs are quite flexible retirement accounts, and you can invest in a wide range of assets such as stocks, ETFs, bonds, mutual funds, and types of real estate. There are, however, certain restricted assets that cannot go into an IRA. These include life insurance policies, unhedged short derivatives positions, collectibles, personal property, a primary residence, and certain precious metals.
Will I Owe Taxes When I Make a Withdrawal From an IRA During Retirement?
Yes. Traditional IRAs use pre-tax dollars, giving you an income tax deduction in the year of the contribution. This creates a deferred tax liability. When you make a withdrawal later, you will be subject to pay that deferred income tax, but at the tax bracket you are in when you make the withdrawal. Note that a Roth IRA uses after-tax dollars and does not have deferred tax liability.
Does Trading in an IRA Create a Taxable Event?
No. IRAs are tax-advantaged retirement accounts and would not be subject to a capital gains tax exposure from trading within it; however, all contributions and any gains will eventually be taxed at your tax bracket when you make the withdrawal. Note that at age 73 or 75, depending on the year you were born, the IRS requires you to take required minimum distributions (RMDs), and these would also be taxed at your income tax bracket at that time.
The Bottom Line
There are many considerations to make when shifting money from stocks to bonds in your IRA, such as fees you may have to pay. While you won't have to pay taxes upfront for this re-balancing, you may have to pay them when you withdraw the money later. The amount of taxes you pay, or if you pay any at all, can vary depending on the type of IRA you have as well as what age you are when you make the withdrawals, and how much income you are earning at that time.
