Day trading with a 401(k) retirement account is allowed, but whether or not you should do so needs to be addressed separately.
The volatility in stock markets, and the urge to earn that extra one percent return motivates people in favor of day trading. Those who are experienced know the risks involved, while the inexperienced ones learn it the hard way. Day trading in your 401(k) account is permitted by the IRS, but there are certain restrictions as well.
You are not allowed to take the principal or profits from day trading
Since a 401(k) is a retirement account, you would not be allowed to withdraw the profits or the principal you invest for day trading. All the gains you make have to rest in the 401(k) account and withdrawals are allowed only when you reach the age of 59 ½. In case you choose to withdraw your money prematurely, you will have to pay income tax and a 10 percent penalty that will kill the returns you have made on your money.
Short positions are not allowed
When you take a short position, you are theoretically taking unlimited risk. You basically incur a loss when the stock price goes up and we know there is no limit in terms of upside a stock can have. So, in order to ensure the safety of retirement corpus, the IRS does not permit a person doing day trading in a 401(k) account to take a short position. Hence, when the broader markets are moving downwards, it is likely that you might not be able to effectively do the day trading. While managing a day trading account, it is important to keep track of the important news and events that impact the value of a stock so that the risk involved in day trading is minimized to a significant extent.
Benefits of day trading in a 401(k) account
Unlike a brokerage account where the gains you make from day trading are taxable, it is not the case with a 401(k) account. The gains are tax-deferred. Thus, you make a higher profit after tax when you day trade in a 401(k) account over a brokerage account. These after tax gains are reinvested in your portfolio and you can expect to generate better long term value than doing day trading with a brokerage account.
Advise for those who use their 401(k) account for day trading
What motivates people for day trading is not really all that hard to understand. People expect their retirement portfolio to give them enough money when they retire, but they only have limited money to invest. When the markets move upwards, optimism about making quick money sets in, and people wish to actively manage their funds; and day trading is one way of doing that.
Day trading has some inherent risks as predicting market movement on a daily basis has its own set of complications. It is advised that you should not day trade unless you have prior experience and a thorough understanding of the risks involved. It is best that you allocate only a minority share of your 401(k) portfolio to day trading.