As an active trader, you quite rightly want to reduce the amount of tax you owe on your profits to the legal minimum. At first thought, you might consider trading from a traditional or Roth IRA to shelter your profits. In a traditional IRA, your contributions are tax-deductible and you don’t have to pay taxes until you withdraw the money. You can’t deduct Roth IRA contributions but you can withdraw your money tax-free if you follow the rules. Obviously, your record keeping for tax reporting is greatly simplified using an IRA, since you don’t declare profits and losses. However, further investigation reveals that a 401K is a much better vehicle to tax shelter your trading profits. Here’s why.
Currently, you can contribute only $5,500 a year to your IRA, or $6,500 if over 50 years old. Compare that to the annual contribution limits on a 401K of up to $59,000. If you are serious about active trading, it might take a long time to build up sufficient capital in your IRA to trade the amounts you desire. Furthermore, Roth IRA contributions are income limited. For single filers, the limits start kicking in when your modified adjusted gross incomes hits $116,000, and you can’t make any contributions at all if your MAGI is $131,000 or greater. MAGI includes your income from sources other than your trading, such as a primary job. If you live with your spouse but file separately, your MAGI limit is a mere $10,000.
There are no income limits on 401K contributions beyond the fact that your contributions cannot exceed your MAGI.
While there are no income limits on contributions to a traditional IRA, deductions are limited if you or your spouse also belong to a qualified retirement plan. If you are single and belong to one, your deductions are phased out beginning at a MAGI of $61,000 and eliminated at $71,000. If married and your spouse belongs to a retirement plan, your deductions are curtailed when your joint MAGI reaches $98,000 and disqualified after $118,000.
There are no income limits on 401K contributions.
Choice of Assets
You cannot hold certain assets, known as collectibles, in your IRA, with the exception of certain forms of certain precious metals. You also can’t hold life insurance policies in your IRA. Admittedly, these restrictions don’t usually affect day trading, but they are nonetheless a hassle that you can avoid by using a 401K instead.
You can’t borrow from your IRA nor pledge it as collateral against a loan. The IRA prohibition against borrowing means you can’t borrow money from you broker (margin) to increase your trading leverage. You can borrow up to $50,000 from your 401K, and the interest you pay just adds to your account balance. Margin loans are not a problem in a 401K.
As you can see, a 401K is the right way to shelter your taxable trading profits. For the right way to set up your 401K, contact Traders Accounting for a free consultation.
Contact Traders Accounting for a free consultation
For Trading Business FAQ’s see: https://www.tradersaccounting.com/active-trader-taxes/
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