Portfolio Margin in 401K

O

optionshedge

Hi,

I'd like to trade option credit spreads in a 401K using portfolio margin.

However, I know that margin is typically NOT allowed in a 401K / retirement account.

However, I found several online services that claim I can trade with PM in a 401K account using a self-directed 401K.

Specifically, they said the process would be as follows:

1) apply for EIN for 401K trust entity at IRS website
2) use IRS approved 401K trust / plan documents
3) open a regular trust account at a brokerage, instead of 401K account
4) have trust account apply for PM privileges.

Has anyone tried this? Is anyone using PM in a 401K / retirement account?
 
Quote from optionshedge:


3) open a regular trust account at a brokerage, instead of 401K account
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this is where you went wrong... when they report the P&L to the IRS, they will come collecting, you will then try to claim tax exemption and the IRS will disqualify the plan and you will pay the taxes..

I am not an accountant, but that is what I was told by one when I asked the same question...

in any event, check qualified advise from someone that will be more familiar with the matter and deal with it day in and day out...
 
I have called the following companies they have said that I can trade on margin in a 401K account:

http://tinyurl.com/ml87y7u

http://tinyurl.com/l98ejg9

Specifically, according to them, trading on margin in 401K account is fine, but may generate UBTI tax if you actually borrow money to buy securities.

However, since I trade option credit spreads, I'm not actually borrowing money on margin, but rather just want margin relief and leverage in my 401K account.

I'm just wondering if anyone else is trading on margin in a retirement account, such as 401K or IRA?
 
Quote from optionshedge:

I have called the following companies they have said that I can trade on margin in a 401K account:

http://tinyurl.com/ml87y7u

http://tinyurl.com/l98ejg9

Specifically, according to them, trading on margin in 401K account is fine, but may generate UBTI tax if you actually borrow money to buy securities.

However, since I trade option credit spreads, I'm not actually borrowing money on margin, but rather just want margin relief and leverage in my 401K account.

I'm just wondering if anyone else is trading on margin in a retirement account, such as 401K or IRA?
More...

You cannot trade stocks or stock options using leverage in any form of retirement account or you fill have to pay UBTI account on any profits derived from leveraging.

UBTI is a tax on profits from debt-financed leveraging in a qualified plan. It does not matter whether you pay interest or not so long as there is a contractual debt to the broker. The question is whether you used debt-financed leverage. I think that all stock trading on leverage may be considered debt financed if there is a margin agreement on your account but this could be open to interpretation. Futures trading on leverage is fine and is not debt-financed leverage.

Brokers will allow you to do almost anything you want if your properly-prepared plan document allows it. Most cookie-cutter plans will not allow it but you can get a custom plan that does allow it. You just have to file UBIT tax returns every year if you use debt-financed leverage. Otherwise you are a tax evader with fairly server penalties.

I have had a plan that opened an account with IB that was a "margin account" but I mainly trade futures. So yes, IB and others will open the account, but it will be up to you to deal with the UBIT tax analysis and this may be very complicated - the broker has nothing to do with that when you bring your own plan.
 
Quote from optionshedge:

Hi,

I'd like to trade option credit spreads in a 401K using portfolio margin.

However, I know that margin is typically NOT allowed in a 401K / retirement account.

However, I found several online services that claim I can trade with PM in a 401K account using a self-directed 401K.

Specifically, they said the process would be as follows:

1) apply for EIN for 401K trust entity at IRS website
2) use IRS approved 401K trust / plan documents
3) open a regular trust account at a brokerage, instead of 401K account
4) have trust account apply for PM privileges.

Has anyone tried this? Is anyone using PM in a 401K / retirement account?
More...

There are ways around this. There are firms that will help you create an LLC for your 401K to invest in. They charge a yearly fee for this. This is also how you can invest in a hedge fund with 401K money. The draw back is that the IRS makes you recognize profits from leverage as taxable. So, if you using 4X your equity on average to trade, the IRS will expect to to pay taxes on anything over your equity(75% of your profits). Check with your accountant, he should give you better advise. I've read the tax code but might be wrong.

1245
 
Quote from 1245:

There are ways around this. There are firms that will help you create an LLC for your 401K to invest in. They charge a yearly fee for this. This is also how you can invest in a hedge fund with 401K money. The draw back is that the IRS makes you recognize profits from leverage as taxable. So, if you using 4X your equity on average to trade, the IRS will expect to to pay taxes on anything over your equity(75% of your profits). Check with your accountant, he should give you better advise. I've read the tax code but might be wrong.

1245
More...

It's been a while since I looked at this but that's generally my recollection as well:

1. Create an LLC
2. The 401k/IRA funds the LLC in exchange for ownership units
3. LLC opens an account at the broker
4. The account trades like a typical individual account w/o any IRA-like restrictions
5. Tax accounting for it all becomes your problem

I'm curious if anyone has actually done this at IB? I have no idea how willing brokers are to open up LLC accounts without a personal guarantee (which is prohibited).

Also, if memory serves, I believe this will allow you short stocks without necessarily triggering UBTI (although still have leverage concerns). I want to say that there's a little blurb in the tax code which says borrowed stocks aren't considered debt financed. If that's right, I'm not sure how you would account for the buying power consumed by such a trade...perhaps total sale value.

I'm not an accountant, so definitely don't rely on anything I've said.
 
I agree that if you borrow money to buy additional securities in margin account, you will be subject to UBTI.

However, I think UBTI does NOT apply if you are trading futures or selling option spreads.

Specifically, the margin associated with trading futures or selling option spreads are more of a security deposit, rather than debt used to finance a trade.

For instance, if you sell a naked put under portfolio margin, the amount of "security deposit" required would be less than if you had a non-margin account. But the margin is NOT borrowing money and shouldn't be subject to UBTI.


http://www.pgdc.com/pgdc/legal-and-tax-implications-investing-planned-gifts

"Stocks or other securities purchased on margin, where the margin account represents true debt of the organization, are debt-financed property giving rise to UBTI.4 Thus, income and gains from such investments will be subject to tax to the extent of the percentage of debt financing. Futures and Forwards--The Service has ruled that margin accounts for futures contracts do not represent acquisition indebtedness. In Letter Ruling 8717066,5 the Service found that margin accounts for futures contracts represented indebtedness of the broker to the exempt organization rather than indebtedness of the exempt organization. In effect, the margin accounts are no more than security deposits. Consequently, margin accounts for executory investment contracts are not acquisition indebtedness and do not result in UBTI. The Service ruled that this is the case whether or not funds are borrowed to finance the margin deposit, as long as funds are not borrowed to acquire the securities."
 
Quote from jtrader33:

It's been a while since I looked at this but that's generally my recollection as well:

1. Create an LLC
2. The 401k/IRA funds the LLC in exchange for ownership units
3. LLC opens an account at the broker
4. The account trades like a typical individual account w/o any IRA-like restrictions
5. Tax accounting for it all becomes your problem

I'm curious if anyone has actually done this at IB? I have no idea how willing brokers are to open up LLC accounts without a personal guarantee (which is prohibited).

Also, if memory serves, I believe this will allow you short stocks without necessarily triggering UBTI (although still have leverage concerns). I want to say that there's a little blurb in the tax code which says borrowed stocks aren't considered debt financed. If that's right, I'm not sure how you would account for the buying power consumed by such a trade...perhaps total sale value.

I'm not an accountant, so definitely don't rely on anything I've said.
More...

The broker only cares about the LLC, not the beneficial owners. The liability is limited. This way shorting is fine with an owner being an IRA/401K. The admin you choose to create this will deal with the accounting. Also, it is rare for a broker to ask for a personal guarantee in a PM accounts with an entity. It is not rare in futures accounts.

1245
 
I am not a lawyer. Do not rely on this as legal advice. I am just sharing my possibly incorrect layman's understanding in the hopes that this will help you find the answer from a more authoritative source.

Regarding only the question of a trust shorting equities, it looks to me like the IRS does not think that that creates UDFI, if I correctly understand United States Internal Revenue Service private letter ruling 201434024, of August 22, 2014, page 5 ( http://www.irs.gov/pub/irs-wd/201434024.pdf ), although that ruling was requested regarding a charitable remainder trust rather than a 401(k):

"In Rev. Rul. 95-8, supra, we ruled that a short sale does not create an indebtedness for
purposes of § 514 because it constitutes the borrowing of property rather than money. Rev.
Rul. 95-8, supra, relies on Deputy v. duPont, 308 U.S. 488, in which the Supreme Court held
that a borrowing of property does not give rise to "indebtedness." The taxpayer borrowed stock
and argued that payments made to the lender constituted interest. The court held that although
the taxpayer had an obligation to the lender, such obligation was not an "indebtedness,"
because an indebtedness arises only with respect to the borrowing of money, not the borrowing
of property.

Rulings:
1. The borrowing of stocks by a fund in entering into short positions will not result in
"acquisition indebtedness" as defined in§ 5l4(c) so that none of the distributive share of
a fund's income or gain which is derived from the fund's trading activities, to the extent
attributable to the foregoing transactions, will be treated as "debt-financed property" as
defined in§ 514(b).
[...]"
 
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