Trading Losses in Roth IRA account
Client traded a $125,000 Roth account down to $30,000 in 2007. Can somebody walk me through the thought process on determining whether to close out the Roth account to take the losses?
Thanks in advance,
BKLNYC
Client traded a $125,000 Roth account down to $30,000 in 2007. Can somebody walk me through the thought process on determining whether to close out the Roth account to take the losses?
Thanks in advance,
BKLNYC
Permalink Submitted by John Keiler on Fri, 2008-04-18 19:09
Bumping up because I’m curious also ❓
How many years back can an individual re-characterize if that is what it takes to right off large ROTH losses?
TIA………Jack
Permalink Submitted by Alan Spross on Sat, 2008-04-19 00:20
This is not a recharacterization. To get an itemized deduction for the Roth loss, all Roth IRAs must be closed, and that can be done at any time.
The itemized deduction is only fully utilized if there are other misc deductions to eat up the 2% of AGI floor, and if the taxpayer already has itemized deductions equal to his standard deduction. He also has to be sure that he is not subject to the AMT which does not allow this deduction. Knowing the above will produce a calculation of the current tax savings from closing the Roth accounts at the marginal bracket for state and federal.
This present savings would then be compared to the present value of the loss of future tax free earnings on not only the loss, but the full value of the Roth being closed out over the remaining life expectancy. As a result this decision is rarely worth the savings unless the loss is over 80% of the contributed amounts.
Permalink Submitted by Brandon Laughren on Mon, 2008-04-21 14:26
Alan,
Thanks for your response.
In this instance there was a conversion of $81,000 and subsequent contributions of $6,000. The account value was $121,000 and is now $20,000.
Can you walk me through the steps to decide on closing the Roth? Would the loss be the difference between the $87,000 and the $20,000 current value? When could he open another Roth? Are there articles or other resources you could point me toward to figure out the best way to handle this situation?
Thanks!
Permalink Submitted by Alan Spross on Mon, 2008-04-21 21:29
If this is his ONLY Roth IRA account, his basis from contributions is 87,000. You are correct that the loss is the difference between 87,000 and the amount he receives upon closing the account. If 20,000, then the loss would be 67,000. In this case, if the conversion was done within the last 5 calendar years, there is the added problem of the 10% early withdrawal penalty on the conversion amount remaining. This will further de value the strategy of closing the Roth.
The 6,000 regular contribution would not be subject to tax or penalty, but the remaining 14,000 was funded by a conversion, and if done within the last 5 years, a 10% penalty or $1,400 would be due. This penalty would reduce the net value of any misc deduction.
If his AGI was 50,000 for example, 2% would reduce his loss to 66,000. This would totally eliminate any taxable income, so his tax saving would be the amount he would have paid less the 1,400 early withdrawal penalty. You would need the real numbers in order to determine what his dollar tax savings is by closing the account, and then reduce that savings by the $1,400 penalty, which he would owe even if he owed no regular taxes. Some of the deduction would be lost to the extent it ran his taxable income into a negative figure. In any event, you need to come up with the current tax savings for closing the Roth.
You then have 20,000 which will be earning for his life expectancy, eg 30 years at say 8%, but taxes @ 25% reduces that to 6%. 20,000 @ 6% over 30 years = 115,000 but at 8% (tax free if Roth left open) = 201,000.
86,000 in tax savings for 30 years converts to a present value of around 20,000 figuring a discount rate of 5%. With this particular set of numbers this would be a push, but with real numbers there would probably be an advantage for closing or not closing. As you can see, the assumptions can be subjective. If he needs those dollars today for living expenses, then you can save the math exercise.