Individual retirement accounts offer a great deal of flexibility in the types of investments you can use to fund them, including company stock options. Some other unusual possibilities include real estate, gold and even cattle. In fact, you can fund your IRA with almost anything except insurance, collectibles and stock in an "S" corporation. However, just because you can put stock options into an IRA doesn’t necessarily mean you should. Always weigh the pros and cons first.
Stock Options Overview
Many employers offer stock options to attract and keep good employees, to give them a sense of ownership in the company or to serve as a reward. Once reserved for executives, many companies are now offering them to other employees.
Basically, stock options give employees the right to buy a certain number of shares in the company at a fixed price for a certain number of years. The price at which employees can purchase stock options is generally the current market price, and the hope is that over time, the market price of the shares will increase. If this occurs, employees can purchase the shares at the lower fixed price and sell them at the higher price to earn a profit.
Stock options offer employees the opportunity to share in the growth of the company, and in some cases, can be very profitable. For example, during the 1990s, many Microsoft employees became millionaires through stock options. Aside from the possibility of earning a profit, employees who have the opportunity to purchase stock options often feel they are a part of something and that their efforts make a difference.
While it’s great to make a profit, sometimes the profitability of stock options can cause trouble when you put them inside an IRA. IRAs have contribution limits ($5,500 or $6,500 if you’re age 50 or older in 2013), and they may impose penalties for excess contributions. If you find yourself in this position, remove the excess contributions immediately or check to see whether you can apply them to a future year.
Also, if you need to make a withdrawal from an IRA and you are less than age 59 1/2, it could be subject to a 10 percent penalty in addition to taxes. Finally, not all brokerage firms will allow you to hold stock options in your IRA. Before you make a purchase, check your brokerage's policies.
Investments in IRAs grow tax-deferred, so you don’t have to pay taxes on gains as they occur. However, unlike stock options that you hold in a taxable account, you do not have the ability to write off losses. This could cost you more in taxes currently. For example, if you had your stock options in a taxable account and you had a loss, you could write off your capital losses against any gains to lessen the tax bite.
Based in Atlanta, Patricia Stallworth has been writing finance-related articles since 1999. She is the author of several books including "Minding Your Money," which was featured in the Wealth Building series in “Black Enterprise” magazine. She has a MBA in finance and a BS in education.