Retirement Solutions

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

Update for the Secure Act 2.0 passed on Dec. 29, 2022: The age to start taking RMDs increases to age 73 in 2023 and to 75 in 2033. (See Fidelity.)

Traders use retirement plans in several ways.

They trade or invest within traditional retirement plans for tax-deferred growth. Withdrawals are taxed as ordinary income, and there’s a 10% excise tax on “early withdrawals” made before age 59 ½. Required minimum distributions (RMD) must start by age 72. 

Traders like Roth IRAs and Roth 401(k)s because they are permanently tax-free and there are no RMDs.

You can convert a traditional IRA or 401(k) into a Roth IRA but pay taxes on the value of the account converted.

TAX-ADVANTAGED GROWTH IN TRADITIONAL PLANS

Many Americans invest in financial markets through their 401(k), IRA, or other retirement plans. Take capital gains and losses within the traditional retirement plans with zero tax effect on current-year tax returns. Only withdrawals (or distributions) generate taxable income at ordinary tax rates. The retirement plan does not benefit from lower long-term capital gains rates. Traditional retirement plans aren’t disenfranchised from deducting capital losses since reducing retirement plan amounts due to losses will eventually reduce taxable distributions accordingly.

EARNED INCOME IS NEEDED

Taxpayers can only make retirement-plan contributions if they have earned income, which is self-employment income or wage income. Trading gains are unearned income exempt from self-employment (SE) tax with individuals, partnerships, and S-Corps.

The exception is futures traders who are full-fledged dealers/members of options or futures exchanges; their futures gains on that exchange are subject to SE tax (Section 1402i).

TTS traders can use an S-Corp trading company, eligible for trader tax status (TTS), to pay officer compensation and make retirement plan contributions. (See Chapter 7.)

SOLO 401(K) PLAN

Generally, the best retirement plan for a trader is a Solo 401(k) for TTS S-Corps established on the entity level in connection with officer compensation (payroll). It combines an “elective deferral” (ED) contribution of $20,500 for 2022 and $22,500 for 2023. Plus, a profit-sharing plan contribution (PSP) up to a maximum of $40,500 for 2022 and 2023. The ED is 100% deductible and provides the main tax benefits. The PSP is 25% deductible, so $40,500 PSP divided by 25%-deductible equals a salary of  $162,000. There is also a “catch-up provision” for taxpayers aged 50 and over of $6,500 for 2022 and $7,500 for 2023. The maximum contribution for those under age 50 is $61,000 for 2022 and $63,000 for 2023. For those 50 or older, it’s $67,500 for 2022 and $70,500 for 2023.

You can contribute the ED component to a Roth Solo 401(k), forgoing taxable income deferral on a traditional contribution. The profit-sharing plan contribution is tax deductible as an expense of the S-Corp and must be traditional (not a Roth).

 Traders need an entity to generate compensation; consider an S-Corp trading company. Employee benefits, including retirement and health insurance premiums, occur on the S-Corp level. TTS sole proprietors and partnerships cannot pay wages to the owners, so they cannot contribute to a retirement plan since they cannot create earned income from trading profits like with the S-Corp.

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 in their Solo 401(k) plan the style of trading they do inside retail accounts, so they put off retirement plan contributions until a later date.

Traders often save thousands by deducting Solo 401(k) retirement plan contributions and health insurance premiums. (It’s a higher saving when spouses work in the trading business and maximize retirement deductions.) Tax savings depends on income taxes saved versus payroll tax costs incurred.

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