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With the new 2010 rules coming, I think I have figured out a way to move at least part of a portfolio from a traditional IRA to a Roth IRA with little to no risk, and pay about a third less tax.

I'm hoping folks out there can take a look at this and see if I am off base.

The new rules in 2010 allow me to convert as much as I want from a traditional IRA (for example, a rollover from a previous company 401K) to a Roth IRA - as long as I pay the tax on it.

The rules have always allowed "recharacterization" - basically a "do-over", so you can UNconvert a converted Roth IRA back to a traditional IRA in the same tax year and pay no tax.

And there are these interesting ProShares ETFs:
- UltraPro S&P500 (ticker: UPRO) that is leveraged to have a daily goal of 3X the rise of the S&P 500 (so if the S&P gains 1%, this gains 3%),
and it's opposite:
- UltraPro Short S&P 500 (ticker: SPXU) that is leveraged to have a daily goal of -3X the rise of the S&P 500 (so if the S&P loses 1%, this gains 3%)

So if I try to take the conservative portion of my portfolio from traditional to Roth IRA, I would do it like this:

I am creating *two* different Roth IRA Accounts, let's call them "Bull" and "Bear". Let's say I have $20,000 in cash in the Traditional IRA and I want to move $13,000 to the Roth.

1) Convert $10,000 cash from the Traditional IRA into my Roth "Bull" account and put it all into UPRO
2) Convert $10,000 cash from the Traditional IRA into my Roth "Bear" account and put it all into SPXU
3) Wait for the stock market to move 10% (up or down, it doesn't matter) and sell everything in both "Bull" and "Bear" accounts
4a) If the S&P went up 10%, then theoretically I would have $13,000 in "Bull" and $7,000 in "Bear". Now I recharacterize "Bear" back to a Traditional IRA and remove the obligation to pay tax on the conversion of "Bear".
4b) If the S&P went down 10%, then theoretically I would have $13,000 in "Bear" and $7,000 in "Bull". Now I recharacterize "Bull" back to a Traditional IRA and remove the obligation to pay tax on the conversion of "Bull".
5) Now I have $13,000 in a Roth IRA (either "Bull" or "Bear" depending on how the market went) but I only have the obligation to pay tax on $10,000. My remaining $7000 is back in the Traditional IRA it came from.

Among the risks:
- The stock market doesn't move enough over the course of the year to make this worthwhile (seems unlikely)
- Tracking inaccuracies in UPRO/SPXU mean that they are not the exact opposite of one another (possible)
- IRS decides I did a "Wash Sale", although that seems unlikely since they are not identical funds and I think Wash Sale rules only apply in taxable accounts
- I could have done something more productive with the $20,000 (for example, put it in stocks), so I would say I would only do this with the most conservative part of my portfolio.

What do y'all think?

I've thought about doing this with options, but I worry more about them not moving in step with each other...

Usual disclaimers apply... I am not a lawyer, I am not an accountant, I don't work for the IRS, and if you do this, you do it at your own risk...
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I think I have figured out a way to move at least part of a portfolio from a traditional IRA to a Roth IRA with little to no risk

Neglecting the tax implications entirely, you should definitely read the SEC bulletin at http://www.sec.gov/investor/pubs/leveragedetfs-alert.htm: "Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors".

These ETFs are not intended for buy-and-hold, and over time (i.e., more than 1 day) their performance will not hit the multiple. If they did, then everybody who was bullish long would just buy the 3x fund and make 3 times as much in the long run.

ETR
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What do y'all think?

I offer no opinion of the investment strategy. You have no tax problems.

A clarification on your statement about the wash sale rules. There's no specific exemption of retirement accounts from the rules, but they're moot for sales in a retirement account since gains/losses don't matter from a tax perspective. However, if you sell for a loss in a taxable account, the wash sale rule applies if you buy replacement shares in a retirement account, as we recently discussed.

Phil
Rule Your Retirement Home Fool
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Thanks EarlyToRise, good point.

While I could buy and sell those leveraged ETFs daily, that would surely wipe out any tax gains in investing expenses.

I could probably achieve the same result with options instead of those leveraged ETFs.

Time for a new thread I think... thanks for the input!
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Thanks Phil!

I get the point, if I sell from a taxable account *and take a loss* and then buy the same security in a non-taxable account, then I have done a wash.

I think in this case since everything is happening inside of IRAs then there are no tax implications, I hope...

BTW I'm going to repost my idea using options instead of Ultra ETFs...
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I think in this case since everything is happening inside of IRAs then there are no tax implications, I hope...

BTW I'm going to repost my idea using options instead of Ultra ETFs...


Options inside IRAs? Be sure your custodian allows that - many don't.

AJ
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Actually, I can't figure out how to do this with options.

Conceptually, what I really want is "ILikeBeer Inc's Coin Toss investment". Imagine that ILikeBeer Inc. has 2 classes of shares, "Heads" and "Tails", par value $1 each.

I convert $10,000 from my traditional IRA into my Roth "Heads" account and buy 10,000 shares in "Heads"
I convert $10,000 from my traditional IRA into my Roth "Tails" account and buy 10,000 shares in "Tails".

Then the next day ILikeBeer Inc. flips a coin and
- if it's heads, ILikeBeer Inc. declares a $2 dividend to the Heads shares
- if it's tails, ILikeBeer Inc. declares a $2 dividend to the Tails shares
... and then ILikeBeer, Inc. files for bankruptcy, penniless.

Coming back to my Roth IRAs...
- if the result of the coin toss was heads, then my Heads account now has $20,000 cash in it, and my Tails account is worthless. I recharacterize the Tails account back to a traditional IRA so that I don't pay tax on the conversion.
- if the result of the coin toss was tails, then my Tails account now has $20,000 cash in it, and my Heads account is worthless. I recharacterize the Heads account back to a traditional IRA so that I don't pay tax on the conversion.

Either way I have successfully moved $20,000 from the traditional IRA to the Roth, I now have one Roth IRA account with $20,000 in it but I think I only have to pay tax on the $10,000 what was in the successful acocunt when I converted it. That's the goal of this strategy.

Unfortunately ILikeBeer Inc, doesn't exist. I was thinking I could do this somehow with options but I'm pretty sure my broker won't allow me to write calls unless they're covered, and I think covered calls won't work here.

Any ideas???

Thanks in Advance!
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Any ideas???

Now I will express an opinion about investment strategy. By way of background, I'm from Kansas and of Polish extraction, so I don't deal well with complexity. I also tend toward the half-empty glass. Comes from years of dealing with failing businesses, each of which had a terrific idea.

Channeling my father, it's story time. Continuing the channeling, I may have told it before, but it won't kill you to hear it again.

Not so long ago, on a different TMF board, a breathless fool (note the use of lower-case) told us about this fantastic investment opportunity that had come his way. He couldn't believe his good fortune. It was a sure-fire investment guaranteed to return 11% minimum yearly. Restricted to only a select few, it required an initial minimum investment of $50,000 IIRC. He was getting ready to cash in everything and put it in this unbelievable opportunity.

You can imagine the Fools' responses. The fool's response to the Fools was that we were jealous. Well, you guessed it. It was a Ponzi scheme, and the fool got in too late.

With no offense meant to your unparalleled ingenuity, do you really think you could come up with a sure-fire double your money scheme that someone else hasn't already thought of, thus rendering it, as Mr. Market will do, ineffective?

Phil
Rule Your Retirement Home Fool
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With no offense meant to your unparalleled ingenuity, do you really think you could come up with a sure-fire double your money scheme that someone else hasn't already thought of, thus rendering it, as Mr. Market will do, ineffective?



he's not really talking about doubling his money --he's talking about 'avoiding' some taxes.

• convert $X from t-IRA to Roth(1)
• convert $X from t-IRA to Roth(2)

as it sits, there's income tax on 2X

• in the two Roths, bet opposite directions (eg, buy calls in one, sell calls in the other; buy stock in one, sell short in the other; bet on Philly in one and Dallas in the other)

• one bet wins ,the other loses. so Roth(1) ,say, has $2X, Roth(2) has $2

•recharacterize loser's (Roth(2)) $2 back to t-IRA


••Op's theory is that he now has $2X in Roth(1), but only owes taxes on
$X ..loses the transaction costs, but gains the tax on $X



-b
.... i had a similar idea several years ago ,moving money from IRA to taxable ..can't recall why i decided it was dumb and Dumb <g>
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• convert $X from t-IRA to Roth(1)
• convert $X from t-IRA to Roth(2)

as it sits, there's income tax on 2X

• in the two Roths, bet opposite directions (eg, buy calls in one, sell calls in the other; buy stock in one, sell short in the other; bet on Philly in one and Dallas in the other)

• one bet wins ,the other loses. so Roth(1) ,say, has $2X, Roth(2) has $2

•recharacterize loser's (Roth(2)) $2 back to t-IRA


••Op's theory is that he now has $2X in Roth(1), but only owes taxes on
$X ..loses the transaction costs, but gains the tax on $X


yes, that's the general strategy behind this tax arbitrage (i.e. monetizing the free option being written by treasury dept.) i have been pondering if/how to do this myself.

the relevant tax law (recharacterization rules) clearly lends itself to exploitation; there's no trouble there. the problem instead lies with setting up the trades. the lack of margin capabilities in IRAs makes it tough to do this in a riskless fashion. short investments of any kind are problematic because of collateral posting requirements.

leveraged & inverse ETFs are right out. pure wealth destroyers in any context other than daytrading.

any pair trades i can think off offhand sound rickety, expensive, with too many moving parts.

you really do want 50/50 zero-sum coin flips, but it's tough to find "investments" with that kind of risk/reward profile.

relaxing the constraint for exchange-traded securities.... if you could find an IRA custodian who'd place roulette wagers for you, you could convert a $37K IRA into 37 separate roths of $1K each, then "invest" each roth into a separate number on the wheel in monte carlo. take the winner as a $36K roth; recharacterize all the losers. you'll avoid the tax on $35K, and pay $1K to the casino as a frictional cost.

but while i've heard of some free-wheeling IRA custodians, i don't know any who swing THAT hard. i'm all ears if anybody knows anything.

trp
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trepanne,

You wrote, the relevant tax law (recharacterization rules) clearly lends itself to exploitation; there's no trouble there. the problem instead lies with setting up the trades. the lack of margin capabilities in IRAs makes it tough to do this in a riskless fashion. ...

Actually, you should be able to select any security with option coverage and buy Calls in one account and Puts in the other - this is a common options strategy sometimes referred to as a long straddle strangle, sans the multiple accounts. The Put and Call positions should be almost exactly offsetting; but however you construct it, you stand to loose everything on both positions.

Lets say the strike price is $25. If the closing price happens to be $25, you would still loose everything in both accounts since both options would have exhausted their time-value premium without any spread. In fact, you will need to have one or the other account exceed strike price by some margin to avoid this scenario. Of course you could pick overlapping strike prices; but in that case, you might as well have just left some of the money in cash.

In the final analysis, the the time-value premium of any option contract guarantees that there is some risk of a total, simultaneous loss from both option positions, no matter how carefully you craft the positions. You can limit such risk by straddling more than one security; but you can't eliminate it. This is the principal failing of all of these "secret" schemes you hear on the radio that "guarantee" a profit regardless of which direction the market moves. Good analysis and diversification might help avoid this failing; but usually people that have succeeded at it have just been lucky.

BTW, there might be another, simpler way to construct this. You could buy a long position of something - anything volatile with options coverage would do, but I'd pick something that's both volatile and has a fair chance of rising in value. Put most of your funds into this account. Then fund another account to buy put contracts on that security at your purchase price. If the security falls in price from your purchase, you will have "siphoned off any loss" into this second account at the cost of the time-value premium paid on the option contract. The first account could then be recharacterized. With this strategy you run the risk that your only "tax-free gain" would be from the recharacterization of the second, smaller account, when it gets wiped out by a rise in your first account's investment. You'd have to do some additional analysis to see if this strategy would ever be worth it.

Finally, you have the problem of finding a broker that will let you buy any option contract in a cash account - as all IRAs are required to be. I talked to a few (discount) brokers about it several years ago and they all said that the account had to be margin-enabled to trade any options and that ruled out IRAs. I don't know why that would be necessary to purchase an option contract - since there is no down-side risk - but that's what they all told me. If you find a broker that's OK with it, I'd like to know.

- Joel
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If you find a broker that's OK with it, I'd like to know.

I have written covered calls and cash secured puts in my IRA at TD Ameritrade. But I can't buy options. I agree - it seems silly, as the most you can lose with a purchased option is the option premium.

--Peter
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I have written covered calls and cash secured puts in my IRA at TD Ameritrade. But I can't buy options. I agree - it seems silly


same with Schwab ...fwiw
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Actually, you should be able to select any security with option coverage and buy Calls in one account and Puts in the other - this is a common options strategy sometimes referred to as a long straddle strangle, sans the multiple accounts. The Put and Call positions should be almost exactly offsetting; but however you construct it, you stand to loose everything on both positions.

this is one of the first things i thought of, and it's pretty good, but violates the "riskless" condition needed to qualify as arbitrage.

you can refine this by selling the same straddle outside the roths, in a regular taxable account... that way, if you lose on the long straddle, you've just effectively made a tax-free distribution (minus the commissions/fees/bid-ask spreads)... and if you still have excess capacity to make tax-deferred contributions, you can just recycle the profits on the short straddle right back into your traditional IRA, making the whole thing a wash...

...but this is getting back into the "too rickety/too many moving parts" territory.

Finally, you have the problem of finding a broker that will let you buy any option contract in a cash account - as all IRAs are required to be.

interactive brokers is of course the premier broker for letting you do any stupid, imprudent, fantastically risky speculation that is actually legal, so they are the go-to name for this kind of scheme.

optionsXpress also lets you trade options inside IRAs.

long options are no problem in IRAs custodied at either of those brokerage houses, i believe... although i should disclaim that i've never actually tried to do this.

trp
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trepanne,

I wrote, Actually, you should be able to select any security with option coverage and buy Calls in one account and Puts in the other - this is a common options strategy sometimes referred to as a long straddle strangle, sans the multiple accounts. The Put and Call positions should be almost exactly offsetting; but however you construct it, you stand to loose everything on both positions.

To which you replied, this is one of the first things i thought of, and it's pretty good, but violates the "riskless" condition needed to qualify as arbitrage.

you can refine this by selling the same straddle outside the roths, in a regular taxable account... that way, if you lose on the long straddle, you've just effectively made a tax-free distribution (minus the commissions/fees/bid-ask spreads)...


I assume you mean you can straddle long across the IRAs and then short the straddle in a taxable account.

I think you're wrong about one thing. If you loose everything on the IRAs and make it up in the taxable account, you won't get a tax-free distribution. You'll effectively get a penalty-free distribution; but the IRS will take taxes on the entire gain in your taxable account. And the gain will be short-term, so you'll pay the same in taxes.

Finally, ... and if you still have excess capacity to make tax-deferred contributions, you can just recycle the profits on the short straddle right back into your traditional IRA, making the whole thing a wash...

That wouldn't work for me. I'm not eligible for tax-deferred traditional IRA contributions because I participate in a 401(k) plan.

- Joel
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I think you're wrong about one thing. If you loose everything on the IRAs and make it up in the taxable account, you won't get a tax-free distribution. You'll effectively get a penalty-free distribution; but the IRS will take taxes on the entire gain in your taxable account. And the gain will be short-term, so you'll pay the same in taxes.

all true. i was getting ahead of myself with the "tax free" part, which assumes that either (a) you have lots of capital loss carryforwards to burn (which i do), or (b) you have extra tax deferrals you can use (which i also do). but generally speaking, yeah, the downside on this strategy is penalty-free but not tax-free.

i'm not convinced this angle is at all attractive. for one thing, it involves a whole lot of nonsense, and executing moves i wouldn't otherwise be interested in making - the tax tail wagging the investment dog. i mean, i'm not a ordinarily a customer for multileg options trades on the russell 2K, or whatever....

but to continue the thought experiment... if you really wanted to get down, and were converting large enough sums of money that the tax savings were big enough to put up with significant overhead...

0) [optional] perform in-service rollover out of 401(k) plan, if necessary & feasible. now you have a big honkin' IRA.
1) convert big honkin' IRA into two half-honkin' roths.
2) sign up with a really swingin' IRA custodian (i can make recommendations), and have each of the roths invest in a freshly capitalized LLC.
3) have each of those LLCs open a margin account, funded with all the LLC assets.
4) now go long & short the same option/future/whatever in one roth against the other. game's over when one of the roths gets a margin call it can't meet; sell out both sides at the same time.

that ought to work. i don't think it would run into a UBIT issue either, as long as you didn't use debt funding to acquire the position, just used the borrowing power to satisfy margin posting requirements.

i estimate it would cost in the ballpark of $800 frictional costs.

fun, huh?

trp
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