I am a big fan of using legal tax-avoidance to bring FI even closer. Particularly, taking advantage of the various tax-advantaged accounts to the maximum extent. I recently read Mad Fientist's post "Roth IRA Horse Race" (
http://www.madfientist.com/roth-ira-horse-race/)which describes a strategy to reduce your tax burden on conversions from a Traditional IRA to Roth IRA. However, I think it can be even better than he describes! If my idea is correct, it should be possible to convert a Traditional IRA to Roth IRA while paying effectively no tax! However, I am no CPA, so wanted to get feedback from others here who might have taken advantage of some of various tax-avoidance methods.
In his post, Mad Fientist describes making two Traditional IRA -> Roth IRA conversions one into a Total Stock index and other into a Total Bond index and then keep whichever does better. The expectation is that the performance of the two is uncorrelated or inversely correlated. So my thought was why not take this to its logical extreme by investing the two Roth IRAs in assets which are perfectly anti-correlated.
For instance, you convert $10,000 into each. Then, you invest each $10,000 into opposite sides of the same binary option which has even odds. To give a more clear example, maybe one is betting that Intel stock is above $32 at end of day tomorrow and the other is betting the opposite.
Then, when the options close, one Roth IRA ends up on the right side of the option and has $20,000 and the other has $0. You recharacterize the one with $0 back to a traditional IRA. So now you have moved $20,000 from your Traditional IRA to your Roth IRA while only paying tax on $10,000. Yay!
To extend the idea further, there is no reason to stick to only 2 Roth IRAs. Imagine you have N of them and want to move $100,000 to your Roth IRA. You move $100,000/N into each, do the above, but with an option with N outcomes each with the same odds. One account ends up with $100,000 and the other all have $0 and are recharacterized by to traditional IRA. So, you only pay tax of $100,000/N. By taking N large enough, you can basically pay no tax.
The downside of doing this is that most of the money which ends up in your Roth IRA account is considered as earnings since from the IRS's perspective, you converted $100,000/N and now have $100,000. This doesn't matter if you don't need to withdraw until age 59.5 since you won't pay tax on the earnings. On the other hand, if you need the money sooner, you would end up paying ordinary income tax plus the 10% penalty. This is worse compared to just doing the normal Roth IRA conversion ladder (since after 5 years you pay no tax on withdrawal of the converted amount). However, it is no worse than just withdrawing directly from the traditional IRA.
So I think this proposal lets you never pay tax on amounts that you currently have in a traditional IRA or 401k as long as you don't need them until after 59.5. What do you think?