Maximum 24.5 Percent Tax Bracket for Large Roth IRA Conversions

Do you think clients have to pay income tax on large ($500K++) Roth IRA conversions at the top marginal tax rates? Think again.

July 22, 2010
Sponsored by Jagen™ Investments, LLC

Do you think clients have to pay income tax on large ($500k++) Roth IRA conversions at the top marginal tax rates? Think again. By utilizing the Jagen™ investment strategy, clients may be able to lock in a 24.5-percent rate on big IRA conversions.

A lot of advisors don’t like the idea of clients paying taxes early. They adhere to the mindset of “never pay a tax if you don’t absolutely have to.” Some advisors also still believe that clients might be in lower tax brackets later in life and don’t want to recommend taxable transactions at today’s top federal rate of 35 percent. But what if clients didn’t have to pay at top rates today? A Roth conversion at a 25 percent or less tax rate now will almost guarantee long-term tax savings for high net worth clients with large individual retirement accounts (IRAs). How many clients with large IRAs will be in a retirement tax bracket less than 25 percent?

Jagen™ funds are eligible IRA investments and offer access to very high level institutional money management platforms. In addition, the Jagen™ fund design provides for a variance between the net asset value (NAV) and fair market value (FMV) of each investor’s interest in the funds.

For example, an investor might have an IRA holding Jagen™ fund units valued at $1 million NAV. This same account may only have a $700,000 FMV based on a qualified appraisal of those fund units. The reason for this valuation adjustment involves various features of Jagen™ funds which must be taken into account when determining FMV. Each fund is privately owned by a limited number of investors and fund units are not traded on open exchanges. Investors must commit to holding their fund units for specified terms. Thus FMV will typically be less than NAV during the holding period.

Let’s see how this affects a Roth conversion:

Roth Conversion without Jagen™ Units



Qualified Appraiser’s Discount1

0 percent

FMV of Conversion


Tax on Conversion2



  Roth Conversion with Jagen™ Units

IRA/ Jagen™ NAV


Qualified Appraiser’s Discount1

30 percent

FMV of Conversion


Tax on Conversion2


1Discount for illustration purposes only. Actual discounts, if applicable, will vary. 2Assumes 35 percent maximum federal income tax bracket.

The effective federal tax rate on the Roth conversion using Jagen™ fund units inside the Traditional IRA is 24.5 percent ($245,000 tax / $1,000,000 IRA NAV = 24.5 percent).

What if we were to combine the Roth conversion using Jagen™ shown above with defined benefit plan contributions, a charitable trust (CLAT, CRAT, etc.), NOL carry forwards, current year NOLs or other tax reduction strategy? We can get the effective tax rate down to less than 20 percent or even zero depending on specifics.

Let’s combine the strategy and example shown above with a grantor Charitable Lead Annuity Trust (CLAT). Making the CLAT a grantor trust provides an immediate income tax deduction to the client in the year the trust is funded. Note that grantor trust status also causes any future taxable income to the trust to be taxed at the grantor’s rates and on his/her tax return even though they will not receive the income or cash flow from the trust. Thus prudent investment management must be employed to minimize or eliminate taxable income to the trust during the term.

Assume a CLAT with a 10-year term initially funded with $500,000 and a payout provision of five percent. The charitable payout each year during the term is five percent of the original trust balance ($25,000). Such a trust funded in July 2010, would create an immediate income tax deduction to the grantor of roughly $215,500.

What does this do to the Roth conversion scenario? Using Jagen™ funds as the investment vehicle already reduced the taxable income recognized from the conversion to $700,000. The CLAT charitable deduction of $215,500 reduces the taxable income even further to only $484,500. At the current maximum federal tax bracket of 35 percent as shown in the example, the tax bill in this case is now only $169,575! So the effective tax rate on this client’s $1 million Roth conversion is now just 17 percent. Obviously, this is much more attractive than 35 percent and puts the Roth opportunity back in reach for some of your large IRA clients. (Note: We recognize that using the CLAT still involves the client paying out funds in the form of charitable gifts rather than taxes. In many cases, clients are more amenable to incurring the expense when they can direct the dollars to their favorite charitable causes, private foundations, donor advised funds and others instead of the government.)

Depending on your client’s age and other circumstances, it may be appropriate to establish and maximize a defined benefit plan. In many scenarios clients can achieve annual contributions of $200,000 or more which will offset significant Roth conversion income. The defined benefit (DB) plan and CLAT are just two of the many ways to address the tax problem on large Roth conversions.

Everyone seems to agree on the advantages of Roth accounts and the flexibility they provide in retirement including tax-free treatment of earnings. Yet advisors are often reluctant to recommend wealthy clients take advantage because the conversion tax discussion is unpleasant. This is a fantastic opportunity for sophisticated advisors to add value to their relationships with clients and centers of influence.

Think about which wealthy clients and prospects would benefit from Roth conversions and then consider how much more attractive the transaction is when you remove the only roadblock by solving the tax problem.

For more information, visit Jagen™ Investments, LLC.