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 several ways. You can trade in the retirement plan, build it up with annual tax-deductible contributions, borrow money from a qualified plan to start a trading business and convert it to a Roth IRA for permanent tax-free build-up. Whatever the use, traders often need help through these essential planning opportunities. 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.

You need “earned income”

Retirement-plan contributions, of all types, 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 to this is futures traders who are full-fledged dealer/members of options or futures exchanges; their futures gains on that exchange are considered earned income subject to SE tax (Section 1402i). Business traders can use entities like an S-Corp trading company or S-Corp or C-Corp management company to pay compensation to claim employee-benefit deductions.

Solo 401(k) plan

The best retirement plan for business traders is a defined-contribution Solo 401(k) for S-Corps (or C-Corp management company) in connection with officer compensation (payroll). This plan is only allowed with TTS or another business purpose (it’s not for investment companies). It combines a 100% deductible “elective deferral” (ED) contribution up to $18,500 for 2018 and $19,000 for 2019, with a 25% deductible profit-sharing plan contribution up to a maximum of $36,500 for 2018 and $37,000 for 2019. There is also an ED “catch-up provision” of $6,000 for 2018 and 2019 for taxpayers age 50 and over. Together, the maximum tax-deductible contribution limit for a defined contribution plan is $55,000 for 2018 and $56,000 for 2019, and $61,000 for 2018 and $62,000 for 2019 including the catch-up provision.

Defined benefit plans

Consistently high-income business owners, including trading businesses with owner/employees close to age 50, should consider a defined-benefit retirement plan (DBP) for significantly higher income tax and payroll tax savings vs. a defined-contribution retirement savings plan (DCP) like a Solo 401(k). DBP calculations are complex. DBP calculations are more complicated than a DCP profit-sharing plan. With a DBP, an actuary is required to consider various factors in calculating retirement benefits and annual contributions to the DBP.

The first factor is three-year average annual compensation, and the IRS limit is $275,000 for 2018 and $280,000 for 2019. W-2 compensation may be higher, but the actuary may only input the IRS limit. Compensation determines the accumulated retirement benefit and retirement plan distributions/income during retirement years. The IRS limits retirement benefits per year to $220,000 for 2018 and $225,000 for 2019. Based on the maximum factors possible, the accumulated retirement benefit would be approximately $2.7 million for 2018 and a little higher for 2019.

Roth retirement accounts and conversions

A Roth retirement plan is different from a traditional retirement plan. The Roth plan has permanent tax savings on growth, whereas the traditional retirement plan only has deferral with taxes owed on distributions in retirement. Distributions from a Roth plan are tax-free unless you take an early withdrawal that exceeds your non-deductible contributions to the plan over the years (keep track well).

Consider annual contributions to a Roth IRA. The rules are similar to traditional IRA contributions, with income limits. Also, consider a Roth IRA conversion before year-end to maximize use of lower tax brackets, offset business losses and fully utilize itemized deductions. The 2017 Tax Cuts and Jobs Act repealed the prior option to reverse (recharacterize) a Roth conversion, starting with 2018 conversions.

Do’s and don’ts

Read our blog post (Learn the DOs and DON’Ts of Using IRAs and Other Retirement Plans in Trading Activities and Alternative Investments) and watch our related Webinar.

For more in-depth information on retirement solutions for traders, read Green’s 2018 Trader Tax Guide.