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Roth Hopping: Maximize Returns Within Roth Accounts, Minimize Taxes

Roth Hopping: Maximize Returns Within Roth Accounts, Minimize Taxes

"Roth Hopping," a relatively new and rarely employed strategy, is one that can be of great value to investors with both a Roth IRA and taxable account and who purchase individual stocks.

Roth Hopping attempts to maximize the value of funds within Roth IRAs, while minimizing the taxes on an overall portfolio (including taxable accounts).

Thought Process Behind The Strategy

Roth IRA monies are extremely valuable to investors as the funds are of limited supply (a maximum of $5,500 per year to Roth's can be contributed; $6,500 if over the age of 50) and are forever 100 percent tax free.

There are also no required minimum distributions on Roth accounts once the age of 70 ½ is reached, unlike traditional IRAs and 401(k) accounts. This combination of factors makes $100,000 inside of a Roth account worth much more (after taxes) than $100,000 located in a 401(k), traditional IRA, annuity or a taxable account.

Because these funds are so valuable, an investor wants to be very cautious about how he or she invests within these accounts. The funds within Roth accounts should have both substantial growth/appreciation potential and a good degree of permanent loss protection.

These two attributes allow an individual to take full advantage of the tax-free growth, while avoiding a permanent loss of capital. A permanent loss of capital (think investing in almost any financial security before the 2008 crisis) would be especially detrimental within a Roth since the funds cannot be replaced.

Related Link: Lifetime Income Payments Or Lump Sum: How To Decide?

Some of the best long-term holdings for Roths are stock index funds (NYSE: SPY), high yield bond funds (NYSE: HYG) and real estate funds (NYSE: VNQ). In addition to a low cost index fund/ETF core, if an investor has an interest in purchasing individual stocks, knowing where and when to purchase and sell them is of great benefit.

The Process Of Roth Hopping

With this layout, an investor can maximize the return and minimize the risk/taxes in dealing with individual stocks in relation to their entire portfolio.

  • Once a good quality stock with above average price appreciation potential and a margin of safety is found purchase the security within a Roth account.
  • Once the stock increases in price to the investor's estimate of ‘fair value,' the stock should be sold within the Roth and replaced with a low cost (index fund/‘core') option.
  • If an investor wishes to retain the stock position in his or her portfolio, they can simply rebuy the security in a taxable account.

Benefits Of The Strategy

  • If the stock was purchased defensively, risk would be reduced within the Roth account (again, very important because the funds cannot be replaced).
  • Assuming the stock performed well, overall return should increase within the Roth account; taking full advantage of the tax-free growth.
  • Once the stock reaches ‘fair value,' the margin of safety is gone and the stock should be sold out of the Roth to protect the outsized tax-free gain.
  • If the investor wants to retain the position, purchasing the same security in a taxable account will set the cost basis at a much higher price. This will vastly reduce tax on any further gains.

And if the stock were to decrease in value, the loss can now be ‘harvested' and used to offset other gains. This process can be repeated over and over, and if done correctly with discipline can add significant after-tax returns to an investor's portfolio.

Eric Mancini is the director of investment research at Traphagen Financial Group, an independent investment advisory firm located in northern New Jersey.


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