Your Client’s IRA is Worth TOO Much

Categories: Retirement Strategies

Have you ever considered whether a client’s IRA is worth too much?

Impossible, you say.  The goal is to accumulate as much wealth as possible within the tax favored IRA environs.  I agree completely.  So why pose the question of whether your clients’ IRAs are worth too much?  Because in many cases they are, and it’s a significant problem even though many advisors and clients do not realize it.

The key is how the assets held by the IRA are valued and whether they are being reported properly.  Many IRAs hold alternative assets and/or direct participation programs such as hedge funds, non-traded REITs, BDCs, oil & gas funds, equipment leasing programs and others.  All of these types of assets share a common characteristic – their fair market value (FMV) is difficult to ascertain.  Why is this important?  Because FMV is the value required for all IRA reporting purposes including on Forms 5498 and 1099-R, as well as the value used in calculating required minimum distributions (RMDs).

Consider a client’s IRA holding 10,000 shares of one of these types of assets originally purchased for $10 per share ($100,000 total initial investment).  The IRA statement reflects the asset at $100,000.  Twelve months pass and you recommend a Roth conversion.  What is the current FMV of the 10,000 shares?  It’s probably not $100,000 even though the account statement still shows that amount.  The current FMV is likely much less due to valuation factors such as illiquidity, lack of marketability and others.  What if the proper FMV at that time was only $70,000?  If the account value was never properly updated to reflect the accurate FMV of $70,000 and your client did the Roth conversion, then they paid more tax than required!  They paid tax on $100,000 of conversion value when the correct amount was only $70,000.  That’s $30,000 more taxable income because their IRA was worth too much!

How about the same IRA client but now you’re advising on their RMD instead of a Roth conversion?  If the RMD calculation is done using $100,000, they are taking more out than is actually required.  This results in excess erosion of the IRA assets and more taxable income each year than is necessary.

And lastly, consider the estate value upon the death of an IRA owner.  If the incorrect higher value is used when adding up the total taxable estate, they will be subject to more estate tax than necessary.

I hate to think of how much additional and unnecessary tax has been paid over the years on a wide variety of transactions simply due to the IRA assets being improperly valued.  Now you understand why sometimes an IRA can be worth TOO much.

Author: Joe Luby, CFP®

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One Response to Your Client’s IRA is Worth TOO Much

  1. Joan Masover says:

    Good article. Many alternative assets now report current values, but many do not. Important consideration in estates or Roth conversions.

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