When Does It Make Sense For You To Convert Your Traditional IRA To A Roth IRA?
THE MOST DIFFICULT ASPECTS OF DECIDING WHETHER OR NOT TO CONVERT YOUR TRADITIONAL IRA TO A ROTH IRA IS WHEN TO REALIZE THE TAX PENALTY, AND IF IT MAKES SENSE FOR YOU AND YOUR RETIREMENT PLANS.
For those of you who are unfamiliar with this concept, I would compare it to winning Powerball, and deciding between the lump sum or the annuity. In other words, you are deciding to either pay the taxes now or at some point in the future. It all comes down to two basic questions, when do you think you will need the money, and when is the optimal time to pay the taxes? Well, seeing that the tax component is an inevitability, the real questions should be is there a way to reduce your tax exposure, and how can it be done effectively?
Well, if this is one of the greatest tax opportunities to save money during retirement, why isn’t everyone doing it now? Basically, you’re playing a guessing game, because no one knows for sure what the taxes will be like in the future. The only way to ensure that the scales are assuredly tipped in your favor is to significantly reduce the tax bill associated with the conversion. Sounds easy enough right? Well, lets discuss how the Fair Market Value of certain retirement assets are appraised, and how they can be adjusted.
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FAIR MARKET VALUE
Ironically, Alternative Investments are sanctioned for ownership with in your retirement plan. These assets maintain a certain degree of subjective valuation, but their appraisal requirements fall well with in approved SEC guidelines. The pure fact that these assets can be found and listed on recognized securities exchanges, it becomes easier to assess their intrinsic value at any given point in time.
Valuation Adjustment Considerations
There are many considerations when attempting to calculating FMV for various alternative assets held inside of fully self-managed IRA’s and other retirement plans. Due to the very composition of these alternative investments, various adjustment factors can help when discounting the FMV if applied to real estate transactions or calculating ownership interests. If the situation occurs where a larger current discount is available, one can anticipate a nominal income tax strain during the distributions.
1. Minority Interests – If less than a 10% ownership interest is represented with in the IRA Plan from any one owner. Let’s say Henry has a 10% ownership interest in his family’s software company, with nine other owners each owning the same amount. He is an owner, but he lacks a controlling interest over the other shareholders, and the business as a whole. This affects the value of his shares.
2. Lack of Marketability – Securities that are not traded on a recognized exchange (i.e. NASDAQ, NYSE) have limited liquidity because they are not traded between millions of investors over a specified stock or commodities exchange. It could take a long time to find a buyer for a diluted ownership interest or rental real estate in order to convert to cash. If you are unable to quickly locate a buyer for your shares or your ownership interest, then the value of the underly security is adjusted accordingly.
3. Fractional Interests – Undivided fractional interests in real estate, even if you have a majority holding, tend to be more of a challenge to find a buyer than if you were selling the whole unit. Let’s say Uncle Monopoly died, and left a 46-unit apartment building to 8 different nieces and nephews. If one of the nieces decided to put her ownership interest on the open market, her share now comes with 7 other owners, each with their own agenda. These complications can greatly reduce the value of her share of the apartment building.
Appraisal and Valuation
Fully self-directed IRA’s and 401(k)’s offer a host of benefits, including real control over one’s financial future, real choice over the assets one can invest in, real diversification of one’s retirement portfolio, real asset protection and real tax advantages. When one considers that, at any moment, Congress could ring in a whole new round of federal income tax increases, positioning oneself to side-step the additional liability becomes that much more compelling. By coupling the many benefits available for self-directed IRA & 401(k)’s with the valuation adjustment techniques applicable to alternative assets held in such accounts, a real opportunity exists to preserve one’s accrued wealth for posterity’s sake.
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