Archive for category: Retirement 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.

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.

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®

©2012 All Rights Reserved.

Bankruptcy Protection for IRAs

Categories: Retirement Strategies

The number of bankruptcy filings in the U.S. steadily increased from 2008-2010.  2011 showed a slight decrease from 2010, but there were still 83% more filings in 2011 than in 2007. (All results as of September 30; Source

For tax and financial planning professionals, this means a greater risk that one of your clients has filed bankruptcy…or will file at some point.  In the event of this unfortunate circumstance, it is important to understand the rules surrounding IRAs and how these assets may be protected.

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), debtors have extended protections for their IRAs.  Generally, one must select either the applicable state law or federal law to determine what assets are exempt from forfeiture during the bankruptcy proceeding.  The BAPCPA leveled the playing field and allows debtors to essentially select the better of the two choices for their IRAs.

This article deals specifically with the protections afforded IRAs under the federal law.  More specifically, we will review the protections for accounts which consist solely of IRA contributions and earnings thereon and not rollover contributions from other qualified plans.

These contributory IRAs were allowed complete exemption up to $1,000,000 under the BAPCPA.  Additionally, this amount is indexed over time for inflation.  As of 2012, the statutory exemption amount for contributory IRAs is $1,171,650.  A unique provision in the bankruptcy code also allows for an unlimited increase in this amount “if the interests of justice so require.”  It would be interesting to know what the drafters of this provision had in mind as “interests of justice” in this regard!  In any case, professional advisors should plan around the $1.17 million figure.

The key to protecting as much as possible within the debtor’s IRA is to understand that the $1.17 million of value protected is defined as the fair market value (FMV) of the account as of the date of filing (Title 11 Section 522(a)(2)).  Thus, it is vitally important that the IRA statement reflect the most accurate FMV of all the assets owned.

For IRAs holding traditional marketable securities and cash, the FMV is easy to determine and probably adequately reported on the account statement.  However, alternative investments such as non-listed REITs, hedge funds, private investment funds, limited partnerships, BDCs, private equity investments and others are often shown at their original cost basis.  It is common to find such assets in IRAs where the FMV has not been updated over a long period of time because there were no taxable events to require a more up to date valuation.  In many cases, the current FMV will be considerably lower than the value shown on the account statement and thus the IRA value is overstated.

If the IRA statement shows an overstated value which is higher than the bankruptcy exemption limit, then it is in the best interests of the IRA owner to get the accurate FMV reported by the IRA custodian prior to filing the petition for bankruptcy.  For example, assume an IRA owns an alternative asset with a cost basis of $1.5 million and that is the amount still shown on the account statement.  In this case, over $300,000 of value is at risk in a bankruptcy proceeding because the total account value is greater than the exemption amount of $1.17 million.  If the IRA owner obtains an updated appraisal reflecting the current FMV of the asset as only $1.125 million (a 25% discount), he/she can report this updated information to the IRA custodian who can then properly update the account valuation.  The entire IRA will then be properly exempt from the bankruptcy proceeding.

Well informed advisors can be very valuable even in cases where clients are financially distressed and going through bankruptcy.  Advisors can help protect client assets and continue to manage and advise on such assets since they will not be forfeited if handled properly.

Author: Joe Luby, ®

©2012 All Rights Reserved.

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.

What Is Your Non-Listed REIT Really Worth?

Categories: Retirement Strategies

Non-listed REITs are hugely popular investments with individual investors and their advisors…and usually with good reason.  They tend to produce high streams of income and allow access to large commercial real estate portfolios for relatively low minimum investments.  The typical investor cannot achieve this type of diversification investing directly into shopping centers, large office buildings and other high end real estate deals.

However, additional and exciting opportunities are available to owners of non-listed REIT shares.  These opportunities present themselves when the fair market value (FMV) of the REIT shares is less than the stated net asset value (NAV) of the shares.  For example, non-listed REIT shares are typically priced at $10 during the initial offering period.  Once the REIT is closed to new investors, the price per share reported by custodians can vary significantly.  In many cases account statements continue to reflect the original cost basis price of $10.  Other times, the REIT sponsor may provide updated NAV information based on performance and holdings in the fund.

It’s a little known fact (with a nod and wink to Cliff Clavin from Cheers) that often, the NAV reported on account statements is not the same as the FMV reported for tax purposes.  Some custodians’ policies on determining proper FMV for reporting purposes require them to look beyond the figures reported by the REIT sponsor.  In some cases the custodian may consider the fund’s redemption policy or secondary market transactions if data and transaction history is available.  It is common sense that shares with no redemption rights trading on a secondary market for $6 are not properly valued at the original offering price of $10 and some custodians recognize this.

A recent review of one large custodian’s non-listed REIT valuation policies reflected the following discounts:

REIT Statement Price IRS Reporting Price (1099R, 5498, etc.) Discount
REIT 1 $4.55 $2.57 -43%
REIT 2 $7.66 $3.14 -59%
REIT 3 $8.03 $6.02 -25%
REIT 4 $6.85 $4.93 -28%
REIT 5 $7.32 $5.70 -22%
Average Discount -35%


In each case the tax reporting value was obtained by reviewing secondary market transaction data rather than using the value reported by the REIT sponsor.

How many clients hold non-listed REIT shares in their IRA?  A Roth conversion may not look attractive based on the statement price/value of the account, but may become very attractive at the tax reporting price/value discounted by thirty-five percent.  Consider an IRA holding shares of REIT 1 shown above with a $100,000 statement value (NAV).  The actual value that will be reported for tax purposes on the 1099R for his Roth conversion is only $57,000.  That Roth conversion looks a lot more attractive at $57,000 than at $100,000.

The Roth conversion is only one example.  Advisors and investors should also consider opportunities in the gift and estate tax planning realm.  Proper valuation of assets clients already hold such as non-listed REITs can provide the same type of tax benefits normally associated with family limited partnerships and other closely held business interests.

Stay tuned for our upcoming webinar series with cutting edge topics and speakers!  Schedule and topics to be announced the first week of August.

And get ready for my new book, KEEP IT! Advanced Tax Strategies for IRAs, coming soon!  The book reviews strategies such as the one above in more detail and shows how to use proper valuation of assets to save huge amounts of tax on IRAs.

© 2011  Jagen™ Investments, LLC

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