Extreme Roth Conversion Strategy?

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Extreme Roth Conversion Strategy?

Postby shuchong » Fri Dec 03, 2010 5:54 pm

I was avoiding work today, and came across an article http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1717019 by a law prof at UNC about using negatively correlated investments, coupled with recharacterization, to vastly reduce the tax consequences of a tIRA to Roth IRA conversion.

The basic idea is to split a tIRA into two equal parts, and put one into a volatile investment and another in its mirror opposite, or something close to its mirror opposite. Convert both tIRAs into Roths, wait and see which does better, and recharacterize the poorly preforming one. Essentially, you've paid tax on half your tIRA, but gotten a lot more than half into a Roth. The overall value of your accounts, however, remains the same.

Obviously, this is an extreme strategy, and makes sense only if a) there's more tax saved than potential gains lost and fees paid b) you can find a good, safe way to get negative correlation and c) you have confidence that the IRS isn't going to come after you. Since even the author, a tax professor, isn't sure of c) the whole thing seems ill-advised.

I was wondering though, whether anyone had played a less extreme version of this game and thought it worth it? I think I've seen a few people here mention using recharacterizations if accounts dropped in value, and surely some slice and dice portfolios have accounts in them that are meant to be negatively correlated (if not quite as volatile or quite as negatively correlated as you would want for this strategy).
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Postby ThePrune » Fri Dec 03, 2010 8:17 pm

Articles by academics can stretch your thinking (good) but sometimes in impractical ways.

Roth IRA recharacterization strategies are inherently short term maneuvers. You hope that the converted funds grow after conversion, but if they happen to substantially drop by Oct. of the year following the year of original conversion, you can recharacterize.

I'd personally never attempt this split fund maneuver with investments I expected to exhibit negatively correlated returns (one investment gains, the other falls) over this short, recharacterization time frame . I'd much rather only convert investments I expected to rise, and leave unconverted investments I'd expect to fall. And I'd wouldn't convert at all if I expected a general market correction or worse within the next year; why not just wait and convert after those events?

Now stand back a minute and think about the language I used in this last paragraph. Sounds a lot like "market timing", doesn't it? Market timing is a dicey proposition. So using Roth recharacterization strategies in an implicit market timing context brings with it all the problems associated with that strategy.

As a person who practices annual, partial Roth conversions, I like to place the converted funds in a "fresh" Roth each year. But I view this methodology only as a type of worst case "insurance". On average, I expect my investments to rise over time and therefore would just as soon get them converted into a Roth as early as possible.
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Postby duhmel1 » Fri Dec 03, 2010 10:57 pm

How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.
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recharacterization? ... Celia ... help ...

Postby lethean46 » Fri Dec 03, 2010 11:15 pm

I'll start ... although my memory is not the best, and I'm not an expert on these matters either.

I have read but don't subscribe to the "idea" proposed regarding investing in uncorrelated investments in Roth accounts and then recharacterizing the "loser". It doesn't need to be that fancy or complicated. Uncorrelated assets? REALLY?

The way it went for me ...

I didn't use mutual funds or uncorrelated assets. Rather, I used one stock that I had confidence in and knew the underlying value. I also knew, however, that that stock price could decline - perhaps substantially. (Same principle applies to index funds, too ... )

I set up 2 Roth accounts for 2008. Concurrently, I set up a new IRA account. All 3 accounts were set up as "empty" accounts at VG, i.e., they were not funded accounts. The purpose of setting up the separate additional empty IRA account? ... was to provide a separate IRA account for receiving cash proceeds in the event of a recharacterization. Be prepared. It establishes and documents "separate monies" vis a vis the old IRA account and new IRA account. You can recharacterize TO the new IRA and convert (again) on the same day FROM the old IRA.

2 separate Roths established for the year. Why? you ask. Because ... you want to fund each Roth to the total amount you want to convert for the year. If the price of the asset(s) in that Roth account tank? You can do a recharacterization IN FULL of that Roth account into the new IRA. No math required. Same day - you can convert again from the old IRA - the total amount you intend to convert for the year into the 2nd Roth account.

Ditto 2009. Set up 2 Roth accounts. If need be? be ready (mentally) to set up a 3rd Roth account for 2009. And ... still holding the ONE extra IRA account to receive any potential recharacterizations.

One of those years (I forget now) I converted double the "intended" conversion amount for the year. Meaning? ... the stock price fell by roughly 25%. I sold it in the Roth/or transferred it from the Roth? - but definitely recharacterized it to the NEW empty IRA. Same day?, I converted again ... from the old IRA into the 2nd Roth set up for that year.

I've only recharacterized once. But yes. It was worth it. A "redo". Same $dollar amount converted the 2nd time ... but more shares were converted at the lower price.

2010? I just didn't want to fool with 2 more Roth accounts, and so I set up only 1 Roth account for the year. I've converted 3 times now into that account as I fine tune the total $$ amount to convert for the year. Same stock. So far, so good.

HOWEVER ... if my stocks in the 2010 Roth account should tank by roughly 25% or more yet this year? I'd scramble to open a 2nd 2010 Roth account. Convert (again) from the old IRA the total $$ amount intended for 2010 into Roth #2. Buy the same stock within that 2nd Roth account. (More shares though, right?) And THEN, before year end - recharacterize the loser holding in the 1st Roth back to the new IRA.

I've tried to explain the process I used as best I can. Really, it's a rather simple concept - once you get it. I'm afraid? that I have managed to make it sound more complex than it is.

There are IMPORTANT rules to follow when doing recharacterization and (re)conversion. Technically? I converted, AGAIN. I didn't reconvert.

BUT, you can follow the rules ... AND pick your winner ... after the race is run.

Worth it? Maybe. Look at it this way. It you had converted and then invested a total $$ amount that you had determined that you wanted to convert for the year. OK? And then that "investment" tanked by 50% or more ... but your $$ conversion amount was still on the books and taxable. What would you do? What CAN you do?

A LOT, actually. Learn the RULES, first. Then, learn how to USE the rules - to your advantage. Liable for tax on your total conversion $$ .. ? .. and meanwhile your investment has tanked? Ouch.

So far as I'm concerned? The method is valid. Simple, really. You don't need uncorrelated assets to make it work for you. All you need ... is an understanding of the RULES ... and some market volatility.

Celia ... Can you clarify what I am trying to say?

To the original poster ....

I used one stock in my Roth conversions and single recharacterization over 3 years.

Celia used funds.

The principle used by both of us was the same, however. Convert to a unique Roth. Recharacterize IN FULL back to a new IRA if there is a substantial loss. At any time ... convert again from the old IRA. Market tanks some more? Recharacterize back to the new IRA. Convert again from the old IRA.

As I said. I've only recharacterized once in 3 years. But it's usefull to know the RULES and the process.

2010 is my last conversion year. Done.

Hope that was helpful? Maybe not.

But the takeaway from ALL of the above? ... is that you don't NEED uncorrelated assets AT ALL to make this work for you. Uncorrelated assets is mumbo-jumbo ... if you ask me. I understand the concept, for sure. Uncorrelated ... for how long? A year? Or longer? Or what? When's the tipping point? Could it be within the year? Ooops.

An lone index fund would work just fine. Convert. The market tanks 20% or so??? Pick your own % drop. Then, recharacterization/convert again.

IMO ...

ML




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Postby Wagnerjb » Fri Dec 03, 2010 11:29 pm

duhmel1 wrote:How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.


I have no problem with the more moderate versions of this strategy...for example splitting your IRA up into several volatile asset classes and recharacterizing any that lose money.

However the more extreme versions of this strategy all seem to suffer from serious issues. The example you cite (long fund + short fund) has two problems. First, the sum of the two investment returns is zero in theory, but costs and inefficiencies are likely to make the sum of them less than zero. Second, the sum of the investment returns is zero....but while you were sitting in the long and short funds, the stock market rose 20%. Oops. You have split your $200 IRA into two $100 Roth funds, ending up with $200 (at best) at the end. But you only have to pay tax on the conversion of $100. Congratulations, you have saved $28 in tax. But you have lost $40 in market gains.

I would love to see a REAL WORLD example of how the extreme strategy would work, but all I have seen are theoretical examples. If anybody has real figures (actual prices for puts or calls or other instruments) that facilitate an extreme strategy I would love to see them.

Best wishes.
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Postby Tramper Al » Sat Dec 04, 2010 12:12 am

Wagnerjb wrote:However the more extreme versions of this strategy all seem to suffer from serious issues. The example you cite (long fund + short fund) has two problems. First, the sum of the two investment returns is zero in theory, but costs and inefficiencies are likely to make the sum of them less than zero. Second, the sum of the investment returns is zero....but while you were sitting in the long and short funds, the stock market rose 20%. Oops. You have split your $200 IRA into two $100 Roth funds, ending up with $200 (at best) at the end. But you only have to pay tax on the conversion of $100. Congratulations, you have saved $28 in tax. But you have lost $40 in market gains.

What you described is in essence a riskless, market-neutral pair, no? That would replace cash in my AA. And then you compare the results to a 100% long stock position, in an above average year for stocks? How does that make sense? It seems to me that an argument that requires a wholesale different AA (when the tax strategy does not) is not very convincing.
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Postby lethean46 » Sat Dec 04, 2010 12:33 am

duhmel1 wrote:How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.


Oh my gosh. Why bother with that??? Long in one Roth? And short in the other Roth? because the market might move ... 10%? ... one way or the other? Are you kidding me?

Sorry. I couldn't do that. For one thing? I wouldn't know how to go short. And I don't want to know either. (Famous last words ... Ha.)

It's much simpler than that. The long/short thing ...

Convert and buy an index fund, LONG. Market falls significantly? Dang. What to do? Convert again! into a new Roth and buy the same index fund, LONG. Market tanks significantly again? Rinse and repeat using a new Roth each time. At year end??? Now what? Recharacterize IN FULL - those Roths holding index shares with the highest purchase cost/share.

You are left with one Roth for the year. It holds the original conversion amount that you want to convert for the year. The only holding? in this Roth is the index of your choice. And this Roth holds those shares at the lowest purchase cost/share. (You recharacterized the other Roths to a new IRA).

That's through year end.

So then ... in 2011? Dang. You see the market tank, again. The remaining low cost 2010 Roth account is now down 25% from purchase cost in 2010. AND, you've already paid or are liable for tax based upon "conversion value", not current market value.

What to do now? You have until 10/15/2011 to decide. Meaning? you can recharacterize your 2010 conversion through 10/15/2011.

Great .... and I don't know what I'd do at that point.

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Postby Wagnerjb » Sat Dec 04, 2010 12:33 am

Tramper Al wrote:What you described is in essence a riskless, market-neutral pair, no? That would replace cash in my AA. And then you compare the results to a 100% long stock position, in an above average year for stocks? How does that make sense? It seems to me that an argument that requires a wholesale different AA (when the tax strategy does not) is not very convincing.


OK - bring me a "riskless market neutral pair", and we can discuss the strategy. But the pair better have a high likelihood of experiencing dramatically different outcomes. Simply one long fund and its paired short fund might not do the trick. In that case, you split $200 into two $100 investments and if the market is flat you end up with maybe $197 ($96 and $101) at the end. The guy who stayed in cash has $208 or so. You saved $1 in taxes but lost $11 in investment returns.

If your pair are very likely to have dramatically opposite outcomes, this strategy is more appealing (in theory). Let's see what the real world offers.....

Best wishes.
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Postby market timer » Sat Dec 04, 2010 12:41 am

Wagnerjb wrote:
Tramper Al wrote:What you described is in essence a riskless, market-neutral pair, no? That would replace cash in my AA. And then you compare the results to a 100% long stock position, in an above average year for stocks? How does that make sense? It seems to me that an argument that requires a wholesale different AA (when the tax strategy does not) is not very convincing.


OK - bring me a "riskless market neutral pair", and we can discuss the strategy.


Short S&P futures vs. long Russell 1000 index fund
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Postby Wagnerjb » Sat Dec 04, 2010 12:45 am

market timer wrote:Short S&P futures vs. long Russell 1000 index fund


That doesn't look "riskless" to me. Don't you think those two indices might not track each other perfectly? Couldn't one rise 15% and the other only rise say 12%? Your spread trade could easily lose money in that scenario.

Best wishes.
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Postby market timer » Sat Dec 04, 2010 12:50 am

Wagnerjb wrote:
market timer wrote:Short S&P futures vs. long Russell 1000 index fund


That doesn't look "riskless" to me. Don't you think those two indices might not track each other perfectly? Couldn't one rise 15% and the other only rise say 12%? Your spread trade could easily lose money in that scenario.

Best wishes.


Adjust your tilt elsewhere.
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Postby the intruder » Sat Dec 04, 2010 1:30 am

duhmel1 wrote:How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.


Forgive my ignorance but how do you short an IRA?
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Postby market timer » Sat Dec 04, 2010 1:40 am

the intruder wrote:
duhmel1 wrote:How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.


Forgive my ignorance but how do you short an IRA?


My IRA allowed me to short futures, buy inverse funds, and buy puts.
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Postby duhmel1 » Sat Dec 04, 2010 1:55 am

Wagnerjb wrote:
duhmel1 wrote:How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.


I have no problem with the more moderate versions of this strategy...for example splitting your IRA up into several volatile asset classes and recharacterizing any that lose money.

However the more extreme versions of this strategy all seem to suffer from serious issues. The example you cite (long fund + short fund) has two problems. First, the sum of the two investment returns is zero in theory, but costs and inefficiencies are likely to make the sum of them less than zero. Second, the sum of the investment returns is zero....but while you were sitting in the long and short funds, the stock market rose 20%. Oops. You have split your $200 IRA into two $100 Roth funds, ending up with $200 (at best) at the end. But you only have to pay tax on the conversion of $100. Congratulations, you have saved $28 in tax. But you have lost $40 in market gains.

I would love to see a REAL WORLD example of how the extreme strategy would work, but all I have seen are theoretical examples. If anybody has real figures (actual prices for puts or calls or other instruments) that facilitate an extreme strategy I would love to see them.

Best wishes.


Your example assumes that the market has risen by 20%. What happens if the market drops by 20%. In this case you are still 'neutral' isolated from the drop in the market while a pure market play would be down 20%.

Let's do the calculation in more detail. Take $100 and split it into two IRAs. Let's assume the market goes up 10%. In an ideal world one IRA would be worth $55 and the other $45. You recharacterize the $45 IRA. Net result is that you have the same amount of money but have avoided paying taxes on $55. If you had $100K in the IRA and you were in a 40% federal + state bracket, you avoid taxes on $5K or $2K. You get the same result if the market goes down 10%.

I realize you need to find a fund that shorts the same index to get this to work exactly but I think there is sufficient slack here as long as there is a significant market movement. The timeframe doesn't have to be exact, you can recharacterize anytime until Oct 15th of the following year. Rather than using a fund as your 'short', you may be able to short an ETF that mirrors the index. I don't know if this can be done in a Roth IRA.

I'm making this up on the fly so let me know if there is a problem with my calculations.
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Postby the intruder » Sat Dec 04, 2010 2:20 am

[quote="market timer"][quote="the intruder"][quote="duhmel1"]How about a strategy that utilizes a 'long' index fund in one IRA and a mirror image 'short' fund in the other. Suppose the market moves 10% in the next year (either way), you will have the winner fund in the Roth IRA and the other fund recharacterized in the traditional IRA. The increase in the winner fund avoids tax. I think in essence this is what the OP is suggesting.[/quote]

Forgive my ignorance but how do you short an IRA?[/quote]

My IRA allowed me to short futures, buy inverse funds, and buy puts.[/quote]

How can you do a short transaction since borrowing against the value of the IRA is a prohibited transaction under IRC 4975 which results in taxation of the entire IRA?
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Re: recharacterization? ... Celia ... help ...

Postby xerty24 » Sat Dec 04, 2010 2:21 am

lethean46 wrote:2 separate Roths established for the year. Why? you ask. Because ... you want to fund each Roth to the total amount you want to convert for the year. If the price of the asset(s) in that Roth account tank? You can do a recharacterization IN FULL of that Roth account into the new IRA. No math required. Same day - you can convert again from the old IRA - the total amount you intend to convert for the year into the 2nd Roth account....

I've only recharacterized once. But yes. It was worth it. A "redo". Same $dollar amount converted the 2nd time ... but more shares were converted at the lower price.

I think you lucked out in that you only had your stock drop once. My reading of Pub 590 says you can't reconvert more than once/year, with a minimum waiting period of a month in between. Admittedly the rules may have been different in the past, as I know they used to allow unlimited recharacterizations initially until the brokers screamed that some people were recharacterizing and reconverting every single day their stock dropped and generating reams of paperwork...

Pub 590, pg 29 wrote:You cannot convert and reconvert an amount during the same tax year or, if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, it will be a failed conversion....
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Postby xerty24 » Sat Dec 04, 2010 2:23 am

the intruder wrote:How can you do a short transaction since borrowing against the value of the IRA is a prohibited transaction under IRC 4975 which results in taxation of the entire IRA?

He's not borrowing from it personally (which would be prohibited), he's getting someone else to lend to it. Brokers often don't like to lend to IRAs since they have limited funds (and they can't go after you to make up the difference and your ability to fund them is limited), but some will anyway if you have enough IRA collateral.
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Postby celia » Sat Dec 04, 2010 4:21 am

lethean46 wrote:It's much simpler than that. The long/short thing ...

Convert and buy an index fund, LONG. Market falls significantly? Dang. What to do? Convert again! into a new Roth and buy the same index fund, LONG. Market tanks significantly again? Rinse and repeat using a new Roth each time. At year end??? Now what? Recharacterize IN FULL - those Roths holding index shares with the highest purchase cost/share.

You are left with one Roth for the year. It holds the original conversion amount that you want to convert for the year. The only holding? in this Roth is the index of your choice. And this Roth holds those shares at the lowest purchase cost/share. (You recharacterized the other Roths to a new IRA).


Let's simplify this even more. You don't need to buy funds or stocks that are polar opposites of each other. You could use a stock fund and a bond fund, for example, knowing that they don't move in tandem. Or an international fund. Or even just convert $x of a fund, a few months later convert another $x of the same fund, and latter in the same year, convert another $x of the same fund, where $x is the amount you can afford to pay taxes on. Whatever you start with, it is important that you do each conversion into a new (empty) Roth. Then at the end of the year, you re-characterize everything except the account that has grown the most. If you do this by the end of the year, you will be able to repeat the whole process the following year, after a minimum wait of 30 days.

If you wait until the following year to do the recharacterizations, not only will you have to pay taxes by April 15 on whatever is still in the Roth accounts (you can amend your returns if you convert by Oct 15 of that following year), but you will not want to put the recharacterization funds back into the original tIRA, since Vanguard will then "lock" the account for the rest of the year, preventing you from doing more conversions. That is why lethan46 says to recharacterize into a new tIRA. Then you can continue converting funds that are in your original tIRA.
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Postby Bob's not my name » Sat Dec 04, 2010 5:22 am

Happy Anniversary! One year to the day: viewtopic.php?p=608027
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Re: recharacterization? ... Celia ... help ...

Postby lethean46 » Sat Dec 04, 2010 11:44 am

xerty24 wrote:
lethean46 wrote:2 separate Roths established for the year. Why? you ask. Because ... you want to fund each Roth to the total amount you want to convert for the year. If the price of the asset(s) in that Roth account tank? You can do a recharacterization IN FULL of that Roth account into the new IRA. No math required. Same day - you can convert again from the old IRA - the total amount you intend to convert for the year into the 2nd Roth account....

I've only recharacterized once. But yes. It was worth it. A "redo". Same $dollar amount converted the 2nd time ... but more shares were converted at the lower price.

I think you lucked out in that you only had your stock drop once. My reading of Pub 590 says you can't reconvert more than once/year, with a minimum waiting period of a month in between. Admittedly the rules may have been different in the past, as I know they used to allow unlimited recharacterizations initially until the brokers screamed that some people were recharacterizing and reconverting every single day their stock dropped and generating reams of paperwork...

Pub 590, pg 29 wrote:You cannot convert and reconvert an amount during the same tax year or, if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, it will be a failed conversion....


xerty

Not at all. My stock drops in value all the time, it seems. Negative 20% or 25%? I start paying attention re a possible recharacterization. In Mar 2009, the stock dropped 55%.

In general, I'm not trying to catch a quick bottom so that I can play this game. But if it looks like it's a serious drop and will remain so for some time? That's when I don't want to pay tax on a conversion value that is no longer valid based on current market value. In that case, it's helpful to know the ropes on conversion and recharacterization.

Also, I did NOT REconvert. I "converted" again. There's a difference. Any time I converted again? I used a new Roth. Then before year end, I recharacterized the "loser" Roth by transfering ALL shares of stock to the new IRA which had been opened for the purpose. That required a written letter of instruction to VG.

Key is funding each conversion from the OLD IRA. Maintaining separate Roth accounts so that any one of them can be recharacterized in FULL. And then if necessary, recharacterizing back to the NEW IRA.

OLD IRA vs NEW IRA ... establishes and proves "separate monies".

I am satisfied that the above follows the rules. Just a little tough to explain it clearly. Source for the info was Fairmark.

Yes. It was worth it. A little tedious ... to make sure it went as planned. No hiccups in the process. VG was great.

However, I'm glad conversions and all are almost over for us. The last year is 2010. I wouldn't want to stay on top of/remember this alternate method - year in and year out for many, many years. It's a distraction from the BIG picture which can get lost in too much detail sometimes.

Anyway, I hate to hear it when a newbie is struggling with some of the goofy stuff put out by the industry pros. It's easier than that.

To wit. Learn the Rules at Fairmark. I printed them, used highlighters, etc. Then search for a section that lays out an alternative way. They give the "specifics" that must be followed and give the reasons for each specific which helped with understanding/learning. I printed that out, too, and highlighted. Then opened the accounts required - just in case this all came into play. I wanted to KNOW the info before I needed to use the info. I can panic in the moment, get confused or overwhelmed. Doing the work ahead of time? took all that (emotion) out of play, for me. Pulled my hard file on it and knew how to proceed/what to do. Thank you Fairmark.

Does that make any more sense to you?

ML



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Postby Wagnerjb » Sat Dec 04, 2010 11:48 am

duhmel1 wrote:Let's do the calculation in more detail. Take $100 and split it into two IRAs. Let's assume the market goes up 10%. In an ideal world one IRA would be worth $55 and the other $45. You recharacterize the $45 IRA. Net result is that you have the same amount of money but have avoided paying taxes on $55. If you had $100K in the IRA and you were in a 40% federal + state bracket, you avoid taxes on $5K or $2K. You get the same result if the market goes down 10%.



Let me take your example all the way home. You split your IRA into two $50 accounts and convert both. After a year, you have $45 and $55. You pay taxes of $15 on one conversion, and recharacterize the $45 account. Then you convert the $45 account, paying $13.50 in tax. At the end of this time, you have converted everything to a Roth. You have $100 in the Roth, and you paid $28.50.

I convert my $100 IRA to a Roth, but I leave the money invested in the stock market. It climbs 10% and I now have $110. At the end of this time, I have $110 in my Roth and I have paid $30 in tax. I am way ahead of your example.

The bottom line here is that you have changed your Asset Allocation to a zero-sum investment, while I have left my assets in the stock market. If the stock market plunges, you win...because you took less risk. With moderately positive returns on my investments I win. The only scenario under which you win is if your two investments have very dramatic opposite returns - like -80% and +80% - and the stock market doesn't rise much.

I don't see any problem with the investor who wants to split his IRA up into several accounts and continue to hold risky stock market assets in each account. That guy hasn't changed his AA, so he cannot lose. Its not likely his savings will be great (one investment has to plunge), but the strategy doesn't have any downside that I can see.

Best wishes.
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Postby lethean46 » Sat Dec 04, 2010 12:04 pm

celia wrote:
lethean46 wrote:It's much simpler than that. The long/short thing ...

Convert and buy an index fund, LONG. Market falls significantly? Dang. What to do? Convert again! into a new Roth and buy the same index fund, LONG. Market tanks significantly again? Rinse and repeat using a new Roth each time. At year end??? Now what? Recharacterize IN FULL - those Roths holding index shares with the highest purchase cost/share.

You are left with one Roth for the year. It holds the original conversion amount that you want to convert for the year. The only holding? in this Roth is the index of your choice. And this Roth holds those shares at the lowest purchase cost/share. (You recharacterized the other Roths to a new IRA).


Let's simplify this even more. You don't need to buy funds or stocks that are polar opposites of each other. You could use a stock fund and a bond fund, for example, knowing that they don't move in tandem. Or an international fund. Or even just convert $x of a fund, a few months later convert another $x of the same fund, and latter in the same year, convert another $x of the same fund, where $x is the amount you can afford to pay taxes on. Whatever you start with, it is important that you do each conversion into a new (empty) Roth. Then at the end of the year, you re-characterize everything except the account that has grown the most. If you do this by the end of the year, you will be able to repeat the whole process the following year, after a minimum wait of 30 days.

If you wait until the following year to do the recharacterizations, not only will you have to pay taxes by April 15 on whatever is still in the Roth accounts (you can amend your returns if you convert by Oct 15 of that following year), but you will not want to put the recharacterization funds back into the original tIRA, since Vanguard will then "lock" the account for the rest of the year, preventing you from doing more conversions. That is why lethan46 says to recharacterize into a new tIRA. Then you can continue converting funds that are in your original tIRA.


Ah ... Celia! Thank you very much. I hoped that you would see this thread.

This is so easy ... once you know the RULES. And then, learn the specifics of the way around the rules.

Convert. Convert again. Convert again. All from the OLD IRA ... to 3 unique Roth accounts. Recharacterize in FULL any Roth(s) you chose ... back to the NEW IRA. There is NO reconversion here.

Keep the above transactions within one calendar year. It's simpler that way as Celia explained above.

ML

ps. You DO have an economic loss in the NEW IRA after all of that. But you have avoided paying tax on the full original conversion value. And, you have presumably converted again at a lower cost (more shares, same dollar amount) into a unique Roth account.

I didn't think about when to convert again or recharacterize ... week in and week out. But if the market came up and slapped me in the face HARD? I knew what to do. Had the extra cash available in the OLD IRA. Had the accounts already open and sitting there empty ... all just in case.
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Postby celia » Sat Dec 04, 2010 5:03 pm

lethean46 wrote:I didn't think about when to convert again or recharacterize ... week in and week out. But if the market came up and slapped me in the face HARD? I knew what to do. Had the extra cash available in the OLD IRA. Had the accounts already open and sitting there empty ... all just in case.

same for me, except I opened new Roths as I was doing the conversion. Vanguard will delete unused accounts after a certain period of time.

This came in handy in 2008, during the big bear run. I had started converting during the summer as the market was going down. By October, I was converting like crazy and ended up keeping the October conversions, since the taxes were a "bargain" on the lower IRA balances (even though my tax rate was higher than most people on this board would use for conversion). I figured even if I paid, for example, a 35% tax rate (incl state), by October it was on only 50% of the usual IRA value. So it was like I paid a 17.5 % tax rate on the full value of my IRA.

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