Retirement Solutions

Save thousands in taxes with a high-deductible retirement plan deduction and grow your retirement funds tax-free until retirement.

Retirement plans for traders can be used in several ways. You can trade in the retirement plan, build it up with annual contributions, borrow money from a qualified plan (not an IRA) to finance a trading business, and convert it to a Roth IRA for permanent tax-free build-up. There are plenty of pitfalls to avoid, like early withdrawals subject to ordinary income tax rates and 10% excise tax penalties, and penalties on prohibited transactions.

Earned income is needed

Retirement-plan contributions can only be made if that taxpayer has earned income, which is subject to the self-employment (SE) tax or wage income. Trading gains aren’t earned income and are exempt from SE tax in a partnership or payroll taxes in an S-Corp. The exception is futures traders who are full-fledged dealers/members of options or futures exchanges; their futures gains on that exchange are considered earned income subject to SE tax (Section 1402i). TTS traders can use entities like an S-Corp trading company or S-Corp, or a C-Corp management company to pay officer compensation to make retirement plan contributions. (see Chapter 7).

Solo 401(k) plan

Generally, the best retirement plan for business traders is a defined-contribution Solo 401(k) for S-Corps established on the entity level connected with officer compensation (payroll). This plan is only allowed with TTS. It combines a 100% deductible “elective deferral” (ED) contribution of $19,500 for 2020 and 2021 with a 25% deductible profit-sharing plan contribution (PSP) up to a maximum $37,500 for 2020 and $38,500 for 2021. There is also an ED “catch-up provision” of $6,500 for 2020 and 2021 for taxpayers age 50 and over. Together, the maximum tax-deductible contribution is $57,000 for 2020 and $58,000 for 2021, and $63,500 for 2020 and $64,500 for 2021 when the catch-up provision is included.

The ED can be contributed to a Roth IRA, forgoing the tax deduction on the contribution. The profit-sharing plan must be traditional (not a Roth), and it’s tax-deductible.

Traders need an entity to generate compensation; we recommend S-Corp trading companies or a partnership trading company with an S-Corp or C-Corp management company. Employee benefits, including retirement and health insurance premiums, occur on the S-Corp or C-Corp level.

Many leading brokers offer Solo 401(k) plans on a cookie-cutter basis (which means “free”), and some allow active direct-access trading. Some traders cannot achieve the style of trading they do inside a Solo 401(k) plan.

Traders often save thousands by deducting Solo 401(k) retirement plan contributions and health insurance premiums. (The higher amount when both spouses work in the trading business and maximize retirement deductions.)

Tax savings depends on marginal federal and state income tax rate savings vs. payroll tax costs. A futures trader with lower 60/40 tax rates in a lower income tax bracket living in a tax-free state has less income-tax savings than a securities trader in a top bracket living in a high-tax state. A futures trader with high income may offset compensation and employee benefit deductions against the ordinary income portion of 60/40 rates. (The 40% portion is taxed at ordinary rates, leading to higher income tax savings.)

For more information, see Green’s Trader Tax Guide, Chapter 8, Retirement Plans.