forex ira tax strategy

By Jason Van Steenwyk

Wouldn’t it be nice if you could sidestep a lot of the complex tax rules that apply to traders and currency investors? Ever dreamed of not having to pay current taxes on your trading gains, but having the freedom to reinvest all your earnings immediately back in your profitable forex practice?

Well, it turns out there’s a way – the self-directed retirement account.

What’s a self-directed retirement account?

A self-directed retirement account is an IRA, Roth IRA, solo 401(k), SEP-IRA, SIMPLE IRA, health savings account, or other federally recognized, tax-advantaged long-term savings account which you control directly. The main idea is that using a self-directed account allows the account owner to invest in a much wider variety of asset types that are normally available via conventional investment companies.

Most people are familiar with the concept of owning mutual funds, CDs and annuities within retirement accounts. Some are also aware that you can own individual stocks and bonds and other securities within an IRA or other forms of retirement accounts as well. But the fact is that the IRS allows for a much wider array of investment options than most people are aware of within an IRA – including FOREX.

Self-directed retirement accounts are not exactly routine, but growing more and more popular as investors look beyond the mediocre returns available in conventional assets. They currently comprise about 4 percent of all IRAs, according to Jim Hitt, a principal at American IRA, LLC, an Asheville, North Carolina-based IRA administrator specializing in self-directed accounts.

The advantages to self-directed IRA investing are the same as the advantages for IRAs in general:

  • Up-front deduction of contributions (subject to certain income limits)
  • Deferral of income tax and capital gains tax until you begin taking distributions
  • Protection against creditors under federal law up to $1 million for IRAs

The advantages of FOREX trading are generally magnified because active trading generates a lot of taxes. Tax-advantaged accounts give you the opportunity to shelter these gains for years, and in the case of Roth accounts, possibly allow for a lifetime of tax-free growth.

The major disadvantages to traditional IRAs and other tax-deferred accounts are the limits on early withdrawals and the fact that you must begin taking RMDs, or required minimum distributions (and paying income tax on those distributions) by April 1 of the year after the year in which you turn 70½. You don’t have the option of allowing our account to compound forever./

Additionally, IRAs and other retirement accounts tie up your money by forcing you to pay a 10 percent excise tax on any withdrawals you make before retirement age – normally age 59½ for IRAs and 401(k)s, though a few exceptions apply for hardship withdrawals in the case of IRAs, and for those who retire or leave the workforce early in the case of 401(k)s.

Note: The rules are different for Roth IRAs and for designated Roth accounts in 401(k)s. With Roths, while you don’t get to take a tax deduction on contributions (in other words, you contribute with after-tax money), you don’t have to pay income or capital gains taxes at all on any money, at any time, as long as it remains within the account for at least five years.

Borrowing and Leverage
It’s a common misconception that you cannot borrow money within your IRA. This is not true. Your IRA can borrow money and can employ leverage. It can only do so on a non-recourse basis. That is, creditors can have no option to place a lien on or claim as collateral anything outside of the IRA itself.
Furthermore, you cannot put your IRA up as collateral itself. But you can use borrowed money in your IRA to boost returns in your forex account. (Or losses, as the case may be. Stuff happens.)

IRAs Aren’t Totally Tax-Deferred
Most people don’t realize it, because it never comes up. But IRAs aren’t totally tax-deferred under all circumstances. If you use leverage within your IRA (very common among forex traders), your IRA may be subject to a special tax on income within the IRA attributable to the money you borrow. This tax is called “unrelated debt income tax,” or, more precisely, tax on unrelated debt-financed income, which the IRS levies on tax-exempt entities and retirement plans.

IRAs are definitely subject to UDIT. In some cases, however, 401(k)s are exempt from this particular tax. Consult your tax advisor for specifics on how this may apply in your individual circumstance.

Under IRS rules, you are strictly prohibited from intermingling IRA assets with your own. You’ll also need to select an IRA custodian or administrator that is knowledgeable about self-directed retirement accounts. Three prominent examples include:
American IRA, LLC
New Direction IRA
Advanta IRA

Allowable Transactions
The nice thing about self-directed IRAs and other retirement accounts is that you can invest in almost anything you like. For this audience, of course, the primary interest is going to be in direct FOREX plays and in the FOREX futures market – both of which are absolutely fair game and completely legal within a retirement account.

In addition to the custodian, you’ll need a broker to handle your transactions. The key is that you cannot control the assets in your IRA directly, but must go through a third party, or you may run afoul of conflict of interest rules.
If you want to diversify out of FOREX within your IRA, you can do that, too, into cash, stocks, funds, bonds, and even real estate. As long as you don’t invest IRA money into certain prohibited investments, you will be alright. Prohibited investments include:

  • Life insurance
  • Collectibles
  • Art
  • Alcoholic beverages
  • Jewelry
  • Certain forms of precious metals and bullion
  • Gemstones
  • Stamps
  • Coins (Exception.   Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.)

If your IRA buys any of these collectibles, the IRS will consider any amount you buy to be an immediate distribution, and you’ll have to pay taxes and penalties, if any, on the amount.

Prohibited Transactions
You also cannot buy or sell directly from or to your IRA, nor from or two any direct ascendant or descendant, nor any of their spouses, nor to or from any entities that prohibited individuals may control. Additionally, your IRA may not directly transact with any entities controlled by any of these parties, nor with anyone who is a fiduciary, entrusted with advising you on or administrating your account.

Self-directed retirement investment isn't for everyone. FOREX investing is risky whether it's within a retirement account or without it. Consider FOREX IRA investing in the context of a diversified portfolio involving many different types of assets, and keep an eye on your long-term goal.

Thank you for reading!

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