I'm new IRAs and I have both a traditional and Roth. My plan is to buy stocks in the IRA and buy protective puts in the Roth that guaranty a maximum risk of 5% or less across both accounts. I expect the Roth's balance to decrease slightly during good market swings but take larger gains when the market is down. The IRA on the other hand, will gain modestly on market ups and lose its value to the Roth on market downs. My motivation for this is to benefit from losses in the IRA by reclaiming losses in the Roth with the put. Therefore, if a stock's value in the IRA were to drop 50%, the Roth reclaims that 45% (-5% for the puts premium) by selling the put. The 45% was essentially transfered to a tax free shelter (This money came into IRA tax free and then leaves the Roth Tax free when I retire). I may have lost 5% but I will be insuring that 45% of the position is now sheltered from a tax rate > 5% when I retire. Is this a sound approach or are there holes i'm not seeing (I am new to options too so I realize I may have unreasonable expectations)? Is it legal to intentionality setup my IRA to drop in value order to increase the value of my Roth?

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    "Funneling" always has such a negative connotation when used to refer to financial matters. – JohnFx Apr 27 '11 at 0:33

I am not a lawyer, but I can't think of a reason this is illegal (something that would be illegal would be to "trade with yourself" across the accounts to try to manipulate stock or option prices). I don't think you're "funneling," you're doing "asset location" which is a standard tax planning strategy.

http://news.morningstar.com/articlenet/article.aspx?id=154126&t1=1303874170 discusses asset location.

I'd be more concerned about whether it makes sense.

  • There is no value in avoiding taxes by not making money. Would you rather pay 30% taxes on a million dollars or zero taxes on zero dollars?
  • How do you know whether the downside or the upside will be larger? Historically, the stock market goes up on average, not down on average.
  • Wouldn't the best strategy be for both IRAs to go up? Why do you want only one of them to go up? If you know the puts will win and the stocks will lose, don't buy the stocks. (I realize you don't know, but then your tax planning might work in reverse!)
  • 5% is probably an overoptimistic price on those protective puts. The SPY 135 put expiring in 325 days currently costs about 8%, and it's for only 11 months not a year, and volatility is low right now. Puts on individual stocks will cost more than index puts.
  • More cost-effective would be a collar instead of only puts. To do this you would have to invest in stocks or ETFs that have liquid options associated with them so you can sell a covered call. (Brokerages for non-rich individual investors won't let you write a SPY option on an S&P500 mutual fund, even though economically speaking that's probably reasonable.)
  • Options are sort of high-maintenance, you have to keep up with the expirations and roll them, and avoid doing anything emotional in the process. They also have significant illiquidity (bid-ask spreads).
  • If you want hedged equity investments, there are a lot of mutual fund options, some examples (not recommendations): Bridgeway Managed Volatility, Hussman Strategic Growth, Gateway Fund (caution: load), PIMCO All-Asset All-Authority, PIMCO Multi-Asset. But just a balanced fund or target date fund can do the job too: http://blog.ometer.com/2010/11/10/take-risks-in-life-for-savings-choose-a-balanced-fund/ Anyway lots of choices out there that might match the desire for more stability than straight stocks, without creating a lot of work for yourself.
  • There's no free lunch! If you find one, check your math. The safety of puts for example costs a lot of money on average.
  • Thanks for your answer. I'm planning on using the protective put strategy and I have a screener that helps me find 5%-7% protected positions with IBD50 and canslim stocks and expirations 150 days out or greater. My hope was to somehow take a greater loss in the traditional whenever my bet go south but have gains in both the roth and traditional when the position is a winner. My though is that the loss will be partially erased at retirement with the relocated funds into the Roth. I am considering accepting your answer. – Tim Santeford Apr 27 '11 at 4:15
  • I can't comment in the trading strategy, I don't know much about that style of investing. If it does work and you can try to locate losses in the traditional IRA, I don't see why it would not be legal to do so. I'd just be careful to never trade with yourself (buy the same thing in one as you sell in the other) because that might be market manipulation. – Havoc P Apr 27 '11 at 4:23

I am not a lawyer but I do not see a legal problem here. However, if the puts in the Roth IRA are not purchased at fair market value that could be a problem. For example, if your traditional IRA sold puts to the Roth IRA below fair market value that would not be allowed. However, from your post, it appears that you will be buying the puts from a third party so that will not be an issue.

There is something else that just cross my mind. Imagine that you own 100 shares of the XYZ stock in your traditional IRA and 100 shares of the XYZ stock outside of an IRA. Now, you buy a put on the XYZ stock inside your Roth IRA. Are the dividends on the XYZ stock still qualified? I do not know but my guess is the answer is no.

  • In your scenario, if the stock drops, I believe the loss may be disqualified due to the Roth puts. I need to research this. – JoeTaxpayer Sep 4 '16 at 0:54

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