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Roth Change Strategy Can Lower Your Tax Bill

Perhaps that rate isn't low enough for you, though. Maybe you need to ensure that the tax rate is even lower, say, 15% or less. Following the example, you'd need to see an increase of 66% or more in your holdings, which would equate to a 33% move in the market (for your leveraged holdings, one way or the other). If the market doesn't move in the amount you hoped, you can just recharacterize the entire conversion, nothing lost.

You probably want to pull your "winnings" off the table and put the remaining Roth IRA into a safe (or safer) investment than the leveraged investments chosen before, such as a balanced fund or even straight bonds.

Now you can pull the same maneuver in the following year with whatever is left in the traditional IRA, splitting it just as before. Over time you should wind up with a significant Roth IRA with a lower tax cost.

This is not a huge payoff strategy -- you'll be losing money in your traditional IRA holdings each year, guaranteed. Your net position would be the same (minus the tax).

After the first year of the example, assuming a 20% gain you'd have $60,000 in the Roth and $40,000 in the traditional IRA, having paid $12,500 in tax. Second year, same result and you'd have $84,000 in the Roth and $16,000 in the traditional IRA, paying $5,000 more in tax. Third year, again the same 20% gain resulting in a total of $93,600 in the Roth, $6,400 in the trad, paying $2,000 in tax. And so on, until the amount gets too small to work with any more.

The end result is that all of this tallies up to the same $100,000 you started with, having paid tax of just less than $21,000 versus the original $25,000 you would have paid. Holding out for a higher return from the strategy would yield a lower tax rate overall.

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