There are many issues to consider when trading options (including calls and puts) or other stock derivatives in Solo 401k or defined benefit plans. The IRS does not expressly prohibit these trades. However, there are complex rules regarding margin accounts (borrowing money) and a concept called Unrelated Business Income Tax (or “UBIT”).
The rules should be clear to IRAs compared to other qualified plans like 401ks and cash balance plans. IRAs are prohibited from borrowing money, but a Solo 401k can borrow money as long as it is considered a “non-recourse loan.” These are critical issues to understand when considering trading options or other derivatives.
Quick Summary
As a general rule, you can use options within a qualified plan as long as you consider the following:
- Your plan document has to allow it.
- The plan fiduciary has to regard it as prudent.
- There can be some unrelated business income tax issues if leveraged.
- The options must be valued at least annually (for defined benefit plans and 401k 5500)
- It could take it out of being eligible for a 5500SF.
Trading Stock Options in a Solo 401k or Cash Balance Plan
Notably, the IRS only sometimes has the ultimate say in what you can do within a self-directed retirement account. The investment custodian (Schwab, Fidelity, Vanguard, etc.) where you establish your account will often have its own rules. In some situations, these rules and more restrictive than IRS rules.
For example, the IRS does allow a plan participant to borrow up to 50% of the security purchase price. But the custodian may allow a lower amount (say 40%). The custodian may also have different or more restrictive policies than the IRS.
The first step is to determine if the IRS allows your transaction. Next, determine if the trade is allowed by the custodian. A qualified plan allows for more flexibility compared to an IRA. Again, consider UBIT, even with a defined benefit plan or solo 401K.
This being the case, if you want to engage in options trading in your retirement plan, look for the term “self-directed.” A self-directed plan will typically give you complete control of your investment options. These plans also generally allow futures, options, futures options, and other complex trading options.
Ensure you understand the difference between setting up a 401k plan with the investment custodian (usually not allowing complete self-direction) or establishing the plan with an investment custodian using a custom-designed plan. The custom plan typically allows you the most flexibility and control over your investments.
Basics When Options Trading in a Qualified Retirement Plan
Typically, self-directed retirement accounts prohibit any derivative or options trading within their accounts. The only exception is covered calls. A covered call is a common option transaction that many people are familiar with. An investor owns the stock and then gives another investor the right to buy that stock at a predetermined price. For this option, the investor receives an option premium.
You must have a plan document that allows for options in your self-directed retirement account. At Emparion, we do not prohibit options or derivative trading inside your retirement accounts.
But we do not review or approve your transactions or trading activity. As a fiduciary, you are in charge of investment compliance. We recommend you work with your CPA or tax professional to ensure your transaction is appropriate.
Can I trade stock options in my Solo 401k or defined benefit plans?
The quick answer is YES. But the main question is will it trigger any UBIT implications? Buying the call or put option itself does necessarily trigger UBIT. This is because the option gives the buyer the right, but not the obligation, to buy or sell the corresponding stock at a specific price on or before a specified date. Assuming an option expires, UBIT will not be applicable. However, UBIT rules would likely apply if a business or trust held the options as inventory or held them for sale to customers in the business’s ordinary operations.
What about futures contracts?
Futures are similar to stocks. Futures trading entails buying and selling specified contracts for the asset’s price in the future. This could include a variety of markets such as agricultural commodities, metals, foreign currency, and other investments where the price fluctuates daily.
Can I do uncovered calls?
Uncovered calls are often referred to as “naked calls.” This is another high-risk strategy because the account could go negative and need funds to cover the call. It is hazardous for 401k and qualified accounts because contribution limits could prevent you from having to pay any amount owed. You are not allowed to personally guarantee the uncovered call with non-retirement funds. No broker or custodian wants to be in a situation where you would owe funds and be unable to repay. Remember, your retirement plan is completely separate from your finances, so you can’t personally repay the money. It’s a similar situation to shorting stocks.
