Active Trader Magazine

The Business of Trading

Retirement plans for traders

By Robert A. Green, CPA

Whether retirement is decades away or right around the corner, it’s never too early or late to start saving and planning, and traders have several options in this area. 

Business traders can save additional income taxes by contributing to a tax-deductible retirement plan. The taxpayer pays a self-employment (SE) tax on administration fees from a partnership, or payroll taxes on salaries in an S-Corp on the earned income component, but usually winds up saving significantly more than that in income taxes. A married couple can save an additional $17,000 or more with individual 401(k) plan contributions and health-insurance deductions. 

A trader can invest or actively trade those retirement assets tax-free until taking normal withdrawals as early as age 59½ or as late as age 70½. Avoid early withdrawals before age 59½ in an IRA — they’re subject to a 10-percent excise tax penalty in addition to ordinary income tax rates. (A few exceptions apply.) 

Small business traders can roll over a 401(k) plan from their last job or an IRA into an individual 401(k) plan and then take withdrawals starting at age 55 without triggering a 10-percent excise tax penalty. A qualified plan allows withdrawals at age 55, whereas IRA holders have to wait until age 59½. Many traders can benefit from that difference. 

Retirement plan contributions can only be made if that taxpayer has earned income, which is subject to the SE tax. Because trading gains aren’t considered earned income (and are therefore exempt from the SE tax in a partnership or payroll taxes in an S-Corp), business traders often use entities to create earned income if they don’t have another source. The exception to this is futures traders who are full-fledged dealer members of options or futures exchanges; their futures trading gains are considered earned income subject to the SE tax (Section 1402i). 

There’s one caveat with all retirement plans: You need to cover all employees in your company and other “affiliated service groups,” such as a related entity you own. Some traders own the majority of equity in another business that hires many employees. They can’t set up a high-deductible retirement plan for themselves in a trading entity without also offering a similar employee benefit to their employees in that other business, too. You can limit this problem by using employee-vesting schedules. Consult a retirement plan tax expert. 

For the complete article, see the May 2012 issue of Active Trader magazine. Click here to subscribe.

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