posted: Jan. 7, 2013 @ 3:49p
Inspired by a worthless post on how to borrow money tax free from an IRA I present an equally complicated way that you can actually put as much money as you can afford into a Roth IRA.
The gist of it is you're going to open two Roth IRAs simultaneously and take completely opposite positions in the two. You will use a complex options strategy to make it very likely that one account will go broke while the other doubles in value. You will then "undo" the contribution to the loser account, while leaving the winning account intact. A contribution can be undone by simply contacting the broker who will return to you your original contribution plus any earnings or minus any losses. Once undone it's like you never made the second contribution so you just have one account with double the yearly contribution limit. The contribution limit for 2013 is $5,500 so the winning account will have $11,000. If that's all you want to do you stop, otherwise continue:
Make two more accounts, do the same trick. Now you have two accounts with $11,000 and two zeroed accounts that have been undone. You then bet the two $11,000 accounts against each other so you have just one account left with $22,000. By now you get the point and you can keep on doing this forever in theory, by simply undoing contributions except for the last one which has all the money in it. Because you always bet on opposite sides of an option bet you're only ever out your commissions.
The specifics of why this should work:
We all know you can only contribute $5,500 to your IRA for the year. But you can open as many IRAs as you want so long as you withdraw all excess contributions and earnings before the end of the year. Publication 590 says: "If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them. If you have an extension of time to file your return, you can withdraw the contributions and earnings by the extended due date. The withdrawal of contributions is tax free, but you must include the earnings on the contributions in income for the year in which you made the contributions." So even if I make 64 accounts at the start of the year and have them battle against each other until there is just one account standing with all the money, I am technically fine so long as I withdraw all contributions for all but 1 of the accounts. I just pick all of the losing accounts to undo, none of which have any earnings to include in income (note you cannot deduct the losses), and I am left with one account with a giant balance. It's as if the first 63 accounts never happened and I just got incredibly lucky with options bets on that one account.
Now what investment could you make that would guarantee one account to double in value and the other to go to zero? You need a broker that will let you trade option spreads. In general IRAs cannot hold short positions in stocks or options, because those have infinite potential losses and they would not let your IRA go negative. But you are allowed to short an option if you limit you loss by buying another option that will offset any losses after a certain point. Let's say the SPY ETF is at $146. What you would do with your $5,500 short 55 call options with a $146 strike while simultaneously buying 55 call options with a $147 strike in the first account. On your second account you do the opposite and buy the 55 $146 strike call options while shorting the 55 $147 strike options. Now the first account will go broke if at the end of the contract SPY is anywhere above $147, and will double in price (net of spread and commissions) if the price ends at anything under $146. The other account will do the opposite. It will double if SPY ends above $147 and be broke if it ends under $146. If it ends in the middle one account will make some money and other will lose the same amount.
Now if you followed any of that, you will probably be thinking you will get killed in commissions and bid/ask spread by buying so many contracts, and while that is the case you could certainly choose much wider spreads which would require you to buy many fewer contracts. If you chose a $5 spread, 145/150 for example, you would only need 11 contracts per account to be pull this off. The downside is you make it more likely that the price will end in the middle and leave both accounts with some money, which would make the process trickier to continue (but not impossible).
So there's my strategy. I can't imagine anyone bothering to try and pull it off on a large scale but from everything I've read it should work. I should also mention you lose the ability to withdraw your contributions tax free like you would have in a normal Roth, because by the end you would have just one account left with all earnings. In my example you have $352,000 which is tax free at 59 1/2, but if you had to take the money out before then it would be subject to tax and penalties, so be sure you won't need the money before retirement if attempting this.
Edit: Also, I realized my math is a little off. If you short an on the money call and buy a $1 out of the money call you have a net credit that's more like 50 cents, so it would take around double the amount of contracts I initially said.