Archive for category: Investment Strategies

Alternative Investments Are Solution To Fiscal Cliff

Categories: Education, Investment Strategies, Retirement Strategies, Tax Strategies

Everyone, including me as of this writing, is talking about the fiscal cliff that we’re rapidly approaching as a nation and will leap off on January 1, 2013.  If you’re reading this, then you already know the fiscal cliff involves, in part, a substantial amount of tax increases.  These increases will make many transactions and events more painful when the individual has to sign the final check made out to Uncle Sam.

Examples of these transactions are IRA-to-Roth IRA conversions, IRA required minimum distributions (RMDs), gifting transactions subject to gift tax, and estate tax calculations.  The amount written on that check to Uncle Sam in all of these events depends directly on the fair market value (FMV) of the assets involved in the transaction.  For example, a one hundred thousand dollar Roth conversion in 2012 will cost a lot less in tax than the same event in 2013.

Interestingly, alternative investments (AIs) offer a major solution to the fiscal cliff problem, yet hardly any broker/dealers or asset sponsors are using this to their advantage.  These entities invariably report the value of such assets at their net asset value (NAV).  NAV is entirely different from FMV (although in some circumstances they may be equal by coincidence but not by definition).  Importantly, FMV is typically much lower than NAV because IRS rules on valuation of non-traded investments (i.e. almost every alternative investment out there including non-traded REITs, BDCs, hedge funds, etc.) require that certain features be taken into account when determining FMV.  These features do not apply when calculating NAV.  Such features include discounts to valuation for lack of marketability, lack of control, illiquidity, and many others.  If a non-traded REIT share has a NAV of $9, but can’t be sold anywhere to anyone on the planet for $9, then why would companies (and consequently taxpayers) report the value as such for taxable events?

The rules say it should be valued at what a neutral third party would pay for it in an arms-length transaction.  The fact that a shareholder can’t find a buyer at $9 should serve as a red flag that this isn’t the proper tax reporting valuation.  Perhaps there are secondary market transactions of this particular REIT in the $5 range.  If so, this is probably more indicative of the proper value to be used in taxable event reporting (actual FMV can only be determined by means of an appraisal).  Imagine the difference in tax owed between a Roth conversion with 10,000 shares at $9 ($90,000) versus a Roth conversion with 10,000 shares valued at $5 ($50,000).  Same asset, same number of shares, same taxable event, but a completely different outcome based solely on proper determination and reporting of FMV as required by the IRS.

Alternative assets have this unique built-in, pre-existing feature that provides this incredible tax benefit.  AI sponsors, selling broker/dealers and advisors to individual clients should all be reviewing these opportunities in order to help their clients turn the fiscal cliff into more of a gentle slope.

Author: Joe Luby, CFP®
©2012 All Rights Reserved.

Fixing IRA Transactions with Alternative Assets

Categories: Education and Resources, General, Investment Strategies, Retirement Strategies, Tax Strategies

Do some of your clients hold alternative investments inside their IRAs?  Have they taken RMDs, completed Roth conversions or other taxable events?  If the answer is yes, then it is very likely that they have a problem.  Alternative assets commonly held in IRAs include non-traded REITs, hedge funds, non-traded BDCs, private investment funds and other illiquid investments.  Such assets can be difficult to value which directly impacts the tax consequences of IRA transactions.  All IRA assets must be reported at their fair market value (FMV) for reporting purposes which for most investments means their trading price.  Alternative assets typically do not trade on established exchanges, and thus can cause adverse consequences for IRA owners when reporting taxable events.

For example, take the case of hypothetical client Mr. Stone who is 71 and has a traditional IRA with a purported $500,000 portfolio of non-traded alternative assets.  This is the value used to calculate Mr. Stone’s taxable 2012 RMD of roughly $18,900.  We take it for granted that this is the correct RMD and the calculation was based on the proper asset valuation.  But what if the illiquid alternative asset was still being valued at Mr. Stone’s original purchase cost from five years earlier with no subsequent update since the asset does not have a readily ascertainable trading price?  It is highly unlikely that the fair market value (FMV) is still $500,000.  If it is worth more, then Mr. Stone could face penalties for not taking the proper amount of RMD.  If it is worth less, Mr. Stone took more money from the tax protected environment of his IRA and incurred more tax than necessary.

A similar scenario occurs where clients completed Roth conversions of IRAs holding alternative assets.  If the investments were overvalued, the client reported excess taxable income and paid more tax than required.  If the investments were undervalued, the client could face unpleasant penalties, interest and additional tax.

Alternative assets are generally subject to valuation discounts for factors such as lack of marketability, illiquidity, lack of control, etc.  So luckily, in the majority of cases we find alternative investments to be overvalued for IRA reporting because these applicable adjustments have not been taken into account.  This means clients often stand to benefit by correcting the errors and requesting a refund of the excess tax paid or reduction of RMD penalties and so on.

The process to correct these issues can be detailed and complex requiring specific actions in a specific order in many cases.   Jagen™ offers direct consulting on these types of cases and can work with you and your clients to complete this process and improve IRA results.  Contact our office to discuss particular client cases.

Author: Joe Luby, CFP®

©2012 All Rights Reserved.

Benjamin Franklin Promoted Tax Alpha

Categories: Education, Education and Resources, Investment Strategies, Retirement Strategies, Tax Strategies - Tags: , , , ,

Clients want more money.  They want growth or income or preferably both, thankyouverymuch.  In every case, they give their advisor a fistful of dollars and expect two fistfuls in return (hat tip to Clint Eastwood).  Rare is the client that asks only for the same number of dollars to be available several years after hiring an advisor.

Advisors typically design a portfolio of assets intended to produce more dollars at some point in the future than the client started with.  The ability to successfully generate excess return over a stated benchmark produces investment alpha.  A positive alpha of 3.0, for example, represents a return three percentage points higher than the benchmark over a specific timeframe.  This is quite a challenge even for the best advisors.  It requires them to be right…a lot.

However, there is a different type of alpha that can be planned for, calculated in advance and achieved consistently.  Such is the nature of tax alpha.  Tax alpha is created when a particular planning strategy results in a reduction of taxes owed.  It provides the same net result as investment alpha, namely, more money in the client’s pocket.

Did you know Benjamin Franklin was the first known proponent of tax alpha?  His quote “a penny saved is twopence dear,” later updated into modern English as “a penny saved is a penny earned,” is directly on point.  A penny saved in tax is just as good as a penny earned from investment performance.  One might contend that Mr. Franklin was speaking against frivolous consumer spending, but I suspect he would equally advise against overspending on taxes as well.

A good advisor will sharpen up on advanced tax planning strategies as much as they will on the latest investment information.  This is especially pertinent in 2012 to help clients limit the cost of pending tax increases slated for January 1, 2013.  Increased tax costs are akin to investment losses in a portfolio while tax savings are akin to investment gains.

One example of how to add tax alpha for clients contemplating wealth transfer strategies can be found in our report titled “Waiter, There’s a REIT in my GRAT!” posted in the Education & Resources section of this site.  And pick up a copy of our book, KEEP IT! Advanced Tax Strategies for IRAs, for many ideas on how to provide significant tax alpha to retirement accounts.  Stay tuned for many more updates and ideas from Jagen™ throughout the rest of the year.

Tax mitigation strategies can provide “guaranteed” returns that are only dependent on following the rules.  Geopolitical activities, investor emotions, market movements and corporate profits have no bearing on returns generated from tax alpha strategies.  Wise is the advisor that can generate investment results via tax savings even if a portfolio is flat.  Ben would be proud.

Author: Joe Luby, CFP®

©2012 All Rights Reserved.

AI Sponsors Will Pay Client’s Advisory Fees

Categories: Investment Strategies, Retirement Strategies, Tax Strategies

Most RIA firms charge advisory fees to clients in the general range of one percent of assets under management annually.  Thus, a $1 million account would incur fee expenses of $10,000 annually.  Is it really possible to get an alternative investment sponsor to cover this expense on behalf of your clients?  In a roundabout way, yes.

Shane has an IRA valued at $1 million and total investable assets of $10 million.  Your asset allocation model calls for ten percent of the portfolio to be allocated to alternative investments such as hedge funds, non-listed REITs, etc.  These assets are often inefficient vehicles for income tax purposes (K-1s, high taxable yields, high turnover, etc.) and are generally designed to be longer term holdings (illiquid, lock-ups, no trading market, etc.).  So you allocate this portion of the portfolio to the IRA which avoids the tax issues and is itself designed as a long term holding vessel.

Shane’s wealth management and transfer planning indicate that a Roth conversion will be very beneficial and ultimately maximize his estate for his beneficiaries.  As you know, the fair market value (FMV) of the assets converted to the Roth IRA is taxable as ordinary income in the year of the conversion.  Luckily (or wisely), you allocated all of the alternative investments in Shane’s portfolio to his IRA.  Why is this lucky or wise?  As described above, alternative investments are typically illiquid, non-traded, minority interests.  When these features exist, there is generally a discount between net asset value (NAV) and FMV.  The tax reporting rules require FMV be used when reporting the value of an asset involved in a taxable transaction.

For example, Shane’s $1 million NAV portfolio of alternative assets may have a FMV for tax reporting of only $650,000 when adjusted by taking into account the fact that the holdings are illiquid, non-traded and so on.  The actual adjustment, if applicable, is determined by an appraisal.  Now consider the net result of the Roth conversion:


IRA w/out Alternative Assets

IRA w/ Alternative Assets










Tax on conversion



Net advantage


Effective tax rate



Hypothetical adjustment of 35%. Actual adjustment, if applicable, will vary. Assumes hypothetical combined state & federal income tax of 40%.

 By virtue of holding the alternative asset portion of the overall portfolio in the IRA and properly valuing said assets for tax reporting purposes, Shane saved $140,000 in tax on his Roth conversion.  Interestingly, this also dropped the effective tax rate on the transaction to only twenty-six percent when you compare the actual tax owed with the account NAV.

Back to the original assertion that alternative investment sponsors will cover your client’s advisory fees.  We already determined that Shane’s annual fee for his IRA is $10,000, and we just learned that he saved $140,000 in tax by owning alternative investments in his account.  Assuming no change in NAV, Shane just saved fourteen years of advisory fees in the form of tax mitigation.  Put another way, you just earned fourteen years of advisory fees in one transaction by properly allocating and valuing your client’s portfolio prior to a taxable event.  Note that while this example used a Roth conversion as the applicable event, the same type of result occurs when using alternative assets in many other taxable transactions including estate and gift tax planning arrangements.

While the alternative investment sponsors didn’t actually write a check to the RIA firm to cover the client’s advisory fees, it was the design of their products that provided the ultimate tax benefit.  Most firms use an asset allocation model that includes some alternative investments already.  Now you know how to use them to provide even more benefit and help pay your advisory fees…in a roundabout way.

Author: Joe Luby, CFP®

©2012 All Rights Reserved.

Liquidity is NOT a Benefit

Categories: Investment Strategies, Wealth Transfer Strategies

I continue to see many references to liquidity touted as an investment benefit.  In fact, it’s often suggested to be the most important benefit when considering different investment choices.  It’s mentioned as such in news articles, online discussions and even some conference presentations.  This is unfortunate for the advancement of industry knowledge and understanding because frankly, it’s wrong.  Especially considering that most references of this type also declare illiquidity as an automatic detractor.

The amount of liquidity inherent in a particular investment is merely a FEATURE.  It is not specifically a benefit or detriment.  Some investments have high liquidity in that they can be traded most days on open exchanges.  Others do not trade at all and still more have various limited liquidity options via redemption or buyback programs.  In each case, the particular liquidity of the asset is merely a feature specific to that asset.

Assume Bill has one million dollars cash.  No argument that his portfolio is completely liquid.  His friend Kevin owns a local McDonald’s restaurant franchise for which he paid one million dollars.  Since the restaurant is wholly owned by Kevin and does not trade on an exchange, he “suffers” from complete illiquidity.  Who is better off?  No doubt some will say Bill, others will say Kevin (especially those who enjoy a Big Mac now and again) but many will come up short in trying to choose between the two.

If liquidity is the most important consideration, or at least the initial and primary consideration before looking at asset type and other criteria, then shouldn’t Bill automatically be in the best position?  Yet no one would advocate holding all of one’s assets in cash to satisfy the liquidity-is-best mantra.

Lest anyone think I’m not being fair because Bill holds cash and doesn’t really have an investment to compare, let’s change the scenario a bit.  Bill now buys one million dollars of publicly traded McDonalds Corporation stock.  Who is better off in this new scenario?  It is impossible to answer on the grounds of liquidity alone which is how many outlets try to frame the issue.

The fact is that both investments have benefits and deficiencies based on their liquidity FEATURES.  If Bill simply holds the shares for five years, he has realized no benefit from the fact they could have been sold during that time.  If Kevin keeps the restaurant five years, then just as Bill did not realize a benefit from the liquidity of his shares, neither does Kevin realize a detriment from the illiquidity of his franchise.  That eliminates the argument referenced in the first paragraph that liquidity is always a benefit and illiquidity always a detractor.

Liquidity is the feature that affords the benefit of being able to reallocate monies to other priorities quickly.  A client with fifty thousand dollars of a liquid investment may decide she would rather apply those funds toward a new automobile.  The liquid nature of the investment provides her the opportunity to move quickly.  Again, liquidity is the feature, buying the automobile when she desires is the benefit.  Similarly, she may own fifty thousand dollars of an illiquid investment which she desires to transfer to her grandchild as a gift.  She does not want the grandchild to be able to convert the asset to cash right away and spend the money foolishly.  Thus, illiquidity is the feature and protecting the grandchild from being a spendthrift is the benefit.

The real underlying questions of whether a particular investment is appropriate for a particular investor must go much deeper than one specific feature of said investment.  Investments are simply tools used to accomplish various financial results.  Just as carpentry tools have different features allowing them to provide different benefits (hammers pound nails, saws cut wood, etc.), so it is with investments.  Degree of liquidity is merely an investment feature providing different benefits which must be weighed together with myriad other criteria when selecting appropriate holdings for specific clients.  When you hear someone demonize an illiquid investment and glorify a liquid one, please help set the record straight and frame the issue properly.

Author: Joe Luby, CFP®

©2012 All rights reserved.

Waiter, There’s a REIT in my GRAT!

Categories: Education and Resources, Investment Strategies, Retirement Strategies, Tax Strategies


The next line in the old joke about a fly in the soup has the offended patron asking the waiter: “what is he doing in there?!”  To which the clever waiter replies: “it looks like the backstroke, sir.”  Please excuse my bad take off on the joke, however, some estate planners might react similarly upon the suggestion of a REIT in a GRAT.  That is, until they discover how much “flavor” this combination really has.

Non-traded REITs are popular and widely held alternative investments with billions of dollars flowing into them annually.  It’s an oxymoron to call a widely held asset “alternative,” but so it goes in the industry.  They are typically sold on the basis of portfolio diversification into commercial real estate and relatively high yields in the form of dividends.  It’s not uncommon to find non-traded REITs yielding between 5% – 7% even in the early stages.  But what do they have to do with GRATs?

Prohibited Transactions Do Not Disqualify an IRA…Always

Categories: Education and Resources, Investment Strategies, Retirement Strategies

The title of this piece probably goes against everything you’ve ever been told or read about prohibited transactions and IRAs.  That’s because (almost) everything you’ve ever been told or read about these transactions is incorrect.  Calm down, control your breathing, it’s going to be OK.  We’ll get through this together.  I used to believe that all prohibited transactions disqualified an IRA also because that’s what I had always heard or read.  That was before a very knowledgeable ERISA attorney corrected me and caused me to review the rules again in an attempt to prove him wrong.  Instead, the rules proved him right.

Who Cares About the AI Market? You Should.

Categories: Education and Resources, General, Investment Strategies, Wealth Transfer Strategies

Dear Friends & Colleagues,

I had an interesting conversation this week.  The founder of an RIA firm in the Midwest contacted me to discuss the concepts outlined in our latest white paper.  The paper is titled “Acres of Diamonds – How to Double the Size of the Alternative Investment Market” and can be downloaded for free here.  Even more interesting is the fact that this firm does not currently use many alternative investments (AI) in their client portfolios.  Why did they read a report about increasing the AI market?

The title may not be catching for attorneys, CPAs and financial advisors thinking “who cares about the size of the alternative investment market.”  However, once you understand the concepts presented, you will scramble to help increase the size of the AI market.  Many will demand more AIs for their clients specifically for the planning opportunities presented.

The call from the RIA firm this week proves my point.  They read the white paper and wanted to know which AI companies followed the policies highlighted in the report.  Specifically, they wanted to talk to those AI firms about starting to allocate significant client funds to their products!  The piece definitely struck a chord with this advisory firm once they realized the amazing financial and tax planning opportunities for clients holding AIs.

And that’s the point.  Attorneys, CPAs and financial advisors who understand the financial and tax planning opportunities hidden within the AI market demand more of these assets for their clients.  So take a look at the white paper and see if some of the concepts strike a chord with you and how they may fit into your client scenarios.

Best Regards,

Joe Luby


Recharacterization & Reconversion of Roth IRA Holding Alternative Assets

Categories: Investment Strategies, Retirement Strategies

October 17th was the deadline to undo (technically “to recharacterize”) a Roth IRA conversion that was done in calendar year 2010.  The law allows recharacterizations until October 15th each year, but this year the 15th fell on a Saturday so the deadline bumped to Monday the 17th.  Many IRA owners choose to recharacterize when the account value decreases after the conversion date.  This makes sense because, for example, who wants to report $100,000 of taxable income on an account that’s only worth $60,000?  And the bonus is they can reconvert back into a Roth IRA at the lower account value.


The key question is: when can one reconvert an IRA that has already been converted and then recharacterized?  This is an often misunderstood timeline.  The rule has two waiting periods: thirty days from the recharacterization date or the next tax year following the year of the conversion, whichever is longer.  Assume the original Roth conversion was done in 2010 and the client recharacterized the account back to a Traditional IRA on October 10th, 2011.  In this scenario, they only need to wait thirty days before reconverting the account back into a Roth IRA.  This is because the original conversion was in 2010 and the recharacterization was in 2011, the next tax year.  Thus, they already met the next tax year requirement, so a thirty day wait is longer than waiting until the next tax year.  If the original Roth conversion occurred earlier in 2011 with the recharacterization on October 10th, 2011, then the client would need to wait until January 2012 before reconverting.


The issue of whether to recharacterize can become even more complicated when the IRA holds alternative assets such as non-traded REITs, hedge funds, BDCs, limited partnerships interests, etc.  These assets are often hard to value and may require formal appraisals to determine the correct amount of income to report on the Roth conversion.  They are also commonly valued at the original investment amount which is almost always incorrect and out of date by the time the IRA owner does a Roth conversion.  It is vital that advisors review the values of alternative assets as shown at the time of the Roth conversion and determine whether an updated valuation analysis would result in a reduced value for reporting purposes.  If so, a recharacterization should be considered.  Then a new valuation can be performed during the applicable waiting period and the account reconverted once the asset value has been properly updated.

Author: Joe Luby, CFP®

©2011 All Rights Reserved.

Where Conservative Investors Should Go as the Rally Continues

Categories: Investment Strategies

As seen on, February 2011
Article By: Joe Luby, CFP®

Speaking at the TD Ameritrade Institutional National Conference in San Diego last week, Wharton finance professor Jeremy Siegel said that the stock market is not ahead of itself. With stocks at 20% below trend line, the current rally will continue, at least for a while. Siegel looks at a 209-year trend line, going back to 1802, which shows a 6.7% annualized real return over that period.

“This market is not overvalued,” said Siegel, adding that, “it’s not too late to get in.” If advisors have clients who’ve been sitting on the sidelines, he suggests encouraging them to get back in while there’s still time.

Bonds, however, are another story. The bond bubble, which Siegel said he predicted six weeks early, is not done yet. Treasury bonds offering thin yields and short-term bonds, paying almost nothing, could result in capital losses if interest rates start to rise.

Where should conservative investors go? Siegel recommends dividend-paying stocks. While the recent big drop in such stocks was due to the financial sector, all of the other nine sectors were doing fine. Stocks are historically cheap according to Siegel. Corporate earnings growth has been strong and he expects this trend to continue. During periods when interest rates remain at 8% or below, the average P/E of the S&P 500 rises to 19. This multiple, combined with estimated earnings for the index topping the 2007 record, shows there is still much upside in the market.

And what about gold? Not so much. Short of a collapse in the global economy or hyperinflation – neither of which are likely, according to Siegel, people who buy gold today will be disappointed in five years.

I’ve seen Dr. Siegel speak at other industry conferences, and while he’s known for his “stocks for the long-run” mantra, I’ve never seen him quite so animated and adamant. His speech was well received, as attendees dined on steak, asparagus and polenta before heading to their afternoon breakout session choices. The main lunch room was filled to capacity and late comers had to settle for the overflow room, with Dr. Seigel’s presentation piped in. Glad I made it into the main room on time!

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