Profitable traders ask me all the time how they are able to reduce their taxes. Through tax planning, I am able to identify many ways to accomplish this task. My single best advice, though, is to go solo…..Solo 401(k) that is! This retirement plan is the perfect vehicle for profitable traders to dramatically reduce their taxes year after year.
The Solo 401(k), also known as the Individual 401(k), was established back in 2001 when Congress passed the Economic Growth and Tax Relief Reconciliation Act. This 401(k) plan is specifically designed for single owner businesses, making it a perfect fit for traders.
THE DETAILS
Here are some of the features of the Solo 401(k) plan:
- Annual contribution limits are $17,500 for 2013 ($23,000 if you are over the age of 50) up to 100% of your compensation.
- Optional combination with a profit sharing plan, allowing you to contribute an additional 25% of your salaried compensation up to a combined maximum of $51,000 ($56,500 if you are over the age of 50).
- Contributions are discretionary, meaning you can vary the amount you contribute each year or omit it if your profitability drops.
- Tax free loans are available.
- Spouses are covered under this plan, doubling your contribution limits and tax savings
- Deadline to open the plan is December 31.
- Contributions must be made prior to filing your taxes, including extensions.
GOOD FIT FOR TRADERS
So why is a Solo 401(k) plan perfect for traders? First of all, as a trader, you are working for yourself and will have no other employees working for you. Secondly, your spouse is covered under this plan, effectively doubling the amount you can contribute each year. Finally, the plan is discretionary, enabling you to adjust your contributions depending on how profitable your trading is for the year. If your profitability is good, you can contribute the maximum. If you are having a difficult year, you can make no contribution. This type of flexibility works very well for traders varying income levels from year to year.
JOE TRADER
Let’s look at an example to illustrate the tax advantages of the Solo 401(k) plan. Joe Trader is a 52 year old trader with a $100,000 profit for the year. Joe’s accountant sets up payroll for Joe, enabling him to create earned income in order to qualify for the Solo 401(k) contributions (see my last article). Joe then “pays” himself $23,000 in salary for the year, but puts the entire $23,000 into his Solo 401(k). He has reduced his taxable income down to $77,000, saving himself $5,750 in taxes!
What if Joe happens to be married? He could also make a contribution of $23,000 for his 55 year old wife. This would drop his taxable income even further and result in a combined tax savings of $11,500!
Keep in mind that you will need to create earned income from your trading business in order to qualify for the Solo 401(k) plan. If you are trading as a sole proprietor, this may mean that you have to incorporate as an S Corp or form an LLC. I would encourage you to discuss this matter with a qualified accountant to find out if it is the right thing for you.
GET STARTED
Remember that the deadline to establish your Solo 401(k) plan is December 31. So don’t procrastinate too much in setting up your plan. You’ll have until March 15 or April 15 of 2014 to make your contribution.
With the potential tax savings you’ll get with this plan, I hope that now you can see why you should go Solo if you want to shrink your taxes!
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[If you have any tax questions at all, please feel free to post them below for Steve Ribble. Check back each month for a new trader tax article on TraderPlanet.]
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Related Reading:
Should You Incorporate As A Trader?
