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 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 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 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 in connection with officer compensation (payroll). This plan is only allowed with TTS (it’s not for investment companies). It combines a 100% deductible “elective deferral” (ED) contribution of $18,500 for 2018 and $19,000 for 2019 with a 25% deductible profit-sharing plan contribution. 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 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 plan contributions and tax savings vs. a defined-contribution retirement savings plan (DCP) like a Solo 401(k). DBP calculations are more complex 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.

Roth retirement accounts and conversions

A Roth retirement plan is different from a traditional plan. The Roth has permanent tax savings on growth and contributions, 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 it over the years (keep accurate records).

Consider annual contributions to a Roth IRA. The rules are similar to traditional IRA contributions. A small business taxpayer is entitled to contribute to a Solo 401(k) Roth.

Also, consider a Roth IRA conversion before year-end to maximize use of lower tax brackets, offset business losses and utilize itemized or standard deductions. If a 2018 converted Roth account drops significantly in value in 2019, a taxpayer can no longer reverse the Roth conversion with a “recharacterization” by the due date of the tax return including extensions (Oct. 15, 2019).

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.

Excerpt from Green’s 2019 Trader Tax Guide Chapter 8 Retirement Plans.