ERICOPOLY

I think this country is on the wrong course with these stupid incentives to give your money to your kids too young (annual gifting from an early age), rather than just eliminating the gift tax & inheritance tax. We're already spending 1 month a year in Australia as it is (visiting family and the beach), but will need to cut it back to 3 weeks a year when the kids start school. Then once their school is done, I want to spend at least 1/2 of the year there (to avoid Seattle's rainy season) and spend July,Aug,Sept in Seattle when it is beautiful. The things I need to figure out are: 1) will the US still be able to get their greedy clutches on my gifting program 2) will Australia respect the tax-free status of my RothIRA if I fall under their tax laws I think I definitely need to hire an expert in these matters.

I am 37, and have two kids but they are ages 2 and 4. I can dribble money to them but I don't yet know how they will turn out. I know people who inherited too much money at 18 and it has effectively robbed them of their initiative. They have low self esteem because of it. Instead, I want to keep it as much of a secret as possible to make sure that they try their best to build a life for themselves. Then, when they are 35 or 40 I will know at that time if it is safe to give them a large sum.

I am starting to think about keeping as much of my future wealth in the family. I am a dual citizen of Australia so naturally I have an idea. At some future time when I am fabulously wealthy, is it possible to just move my residence to Australia and then gift the money away to family? Australia has no gift tax. Australia has no inheritance tax. Is there some "gotcha" in there that would prevent me from doing this? Would it mean that I would owe a big tax in the US if I moved back and got residency in the US once again? It seems too easy, what am I missing?

My kids have their Coverdell accounts with Fairholme (opened accounts directly with them). So Bruce Berkowitz is managing their college savings.

The bank shares are rallying because of a perception that loan losses have peaked. Loan losses do not factor into the values of those other sectors you named.

It's too small to abuse. $2,000 bucks a year max contribution per child.

I think they are actually much more capable of further acquisitions now. First off, you state they need to digest the ORH buyback even though it was paid for by selling $1b in FFH shares. Secondly, the Zenith purchase of $1.3 billion... most of that was funded from last year's profit in addition to YTD profit. So compared to where they started last year they are stronger for two reasons: 1) acquisitions were paid for out of capital raises & earnings 2) they now have significantly higher cash flows at holdco. MUCH higher... added dividend capacity of ORH and Zenith is huge Bulging with cash despite acquisitions (from 2009 AR): "This increase in shareholders’ equity, together with the decrease in net premiums written due to the soft markets, has resulted in a build up of very significant excess capital in our insurance and reinsurance subsidiaries." The soft market has freed up capital to deploy elsewhere.

I don't have state tax thank goodness. One day I might live in such a state -- all the better reason to convert now for my situation. I think many wealthy Californians just have second homes elsewhere to avoid it. Just get a place in Jackson Hole -- it will pay for itself in tax savings if you have enough taxable income.

The return the market demands -- got it. Thanks for the clear explanation.

As Prem points out in the latest annual report, most of the debt is merely a liquidity reserve to be tapped reliably even if the overall financial system is under severe stress, offset by an equal amount of cash and securities at holdco. This debt is not used to achieve returns, but rather used to REDUCE overall risk. It is a hedging strategy against systemic risk. I was primarily involved in stress testing when I was employed, and I designed and implemented a stress automation system for user-mode Windows applications. My automation framework allocated a very large (200mb) chunk of virtual memory as a reserve for the error reporting. When an application crash was detected, I would then free the reserve, collect some data, and send the reports to the database. The data reporting and such required system resources (virtual memory) -- however, under stress the virtual memory may not be available for dynamic allocation... in other words, when the system is under stress everybody else may have already claimed all available virtual memory. So by pre-allocating a large chunk of memory I reduced the risk of being unable to grab system resources when the system was under severe stress (at the very time that the apps I was testing tended to being crashing). In short, Prem seems to be doing the same. This makes Fairfax less risky than the business model would otherwise suggest, because even the best underwriter can be wiped out if the unthinkable claims come in at a time when the capital markets are frozen.

I've got to say I'm confused.

This is something I never have come to understand (likely because I don't have an MBA nor did I ever study the topic). What do you mean by "cost of capital"? Are you talking about the cost of their float? The cost at which they borrow money? Their float does not cost 8-9%, and they borrow money at less than 8-9%. Even if it did cost them 8-9%, those numbers are pre-tax and their ROE is after-tax. So what exactly is costing them 8-9% in your estimation?

Look, if you are not already maxing out your IRA contribution opportunities then perhaps you have reasons for doing so (low on money perhaps). Me, I would do both. I would max out my IRA contribution (if I could make one at all!) and I would ALSO do the Roth conversion to establish the stealth Roth-like tax reserve. This is not mutually exclusive, unless you can't afford to do both. I never can have too much of a good thing when it comes to tax shelters. Taking money out of your IRA (as was suggested previously) to pay the conversion tax is stupid if you have a large taxable account which can easily handle the conversion expenses -- the goal is to maximize tax-deferred compounding, rather than taking money out early to pay off a future tax liability in a shell game that gets you nowhere. I'm not allowed to make regular IRA contributions -- I don't have any earned income. So this conversion opportunity is a bonus -- the only way I can increase my tax-deferred compounding via contributions.

To make the proposal simpler perhaps we can change the wording of the "roth conversion" to "one-time opportunity to make a Roth contribution as large as your tax liability". Pretend that tax rates would be the same. Would you argue that there is no benefit to a large Roth contribution?

Paying the tax today with cash in a taxable account is in effect implicitly a roth-like contribution. That's why it's so beautiful! There is no other special deal for making such a large one-time contribution.

You should note also that my compounding numbers were modest -- 10% in the IRA and 8.5% in the tax reserve. Let's double them and make them 20% in the IRA and 17% in the tax reserve. Now you have a tax liability of $8,308,170 but your tax reserve has only grown to $3,887,262. So your tax is now 113.7% higher than it would be if you'd just do the Roth conversion today. Today, you are looking at that 35% tax and shrugging, saying... oh well, it will still be 35% in 30 years so I'd just as rather pay it then (I think that's Kawihako's thesis). But in reality, under these new numbers I will be paying 35% and he will be paying the equivalent of 74.8%. And here he was saying that 70% was unrealistic!!!

In short... paying the tax today (Roth conversion) is logically equivalent to putting your tax liability in a tax-exempt investment account. Refusing to pay the tax today (no conversion) is logically equivalent to saying "I think it's better to put the tax liability in a taxable account rather than a non-taxable account". I hope people don't make that choice now after seeing the math. (this assuming the tax rate upon conversion is the same as that upon IRA distribution)

Here is the mistake you are making -- you are stating a truth (tax rates the same) but it is leading you to an incorrect conclusion. I'm currently studying for the GRE, and the Princeton Review recommends "plugging in the numbers" to ace the algebra portion. So let's take their advice here and plug in some numbers. Suppose you are faced with the proposition of converting a $100k IRA today to a Roth IRA and paying $35,000 in tax (35%), or withdrawing it from your IRA in 30 yrs and paying the same rate -- 35%. Okay, so you choose not to convert. Then put the same $35,000 into your brokerage account and invest this as your "tax reserve" that you intend to use to cover the taxes on your IRA withdrawals 30 yrs down the road. Now, suppose your IRA compounds by 10% per annum. In 30 yrs time it is worth $1,744,940. So you choose to withdraw it at that time and you owe tax of $610,729. Now, let's say that you invest your "Tax Reserve" in the exact same investments as you held in your IRA, but due to drag from annual taxes due, you only achieved 8.5% per annum. Your tax reserve is now worth $404,538. $404,538 is NOT equal to the tax you owe of $610,729. Sorry, but you should have done the conversion. You just gifted the government $206,191. You are paying 50% more in taxes for your gamble. Your gamble is that you can compound your annually taxed "reserve" at the same rate as your IRA compounds tax-deferred -- good luck, you'll need it.

One other benefit of conversion: 5 years after the conversion, you can withdraw 100% of the conversion amount tax-free (without early withdrawal penalty). So, 5 yrs from now, when I'm 41 I can withdraw the sum of money that I converted to the Roth -- without paying a penalty for withdrawing before age 59.5. The IRA provides no such program -- you pay a 10% early withdrawal penalty in addition to income taxes due on the withdrawal. I don't plan to do that, but it provides the penalty-free option.

I'm in Montana right now home shopping. The Windermere office in Bozeman has a flyer posted in the window with an AR-15 assult rifle drawn on it. The large print is "Are you overtaxed?" If you come to the Republican (militia?) rally, you can enter to win an AR-15 in a raffle. I am still in disbelief -- who knows, perhaps the Republicans will give out enough AR-15 weapons to kill all the liberals and abolish taxes. 33 yrs is a long time for forecasting tax policy.

If you pay $100k from outside the account, then in case #1 the amount you can draw down without any tax penalty is $980k (200k at 8% for 20 years), not $440k. If one doesn't have $100k lying around, the economics are compelling enough that you should take out a short term loan to pay the tax obligation to maintain the $200k balance in the ROTH. I forgot to mention that taking out any loan to pay off the tax obligation would skew the results I've outline below much more in favor of an IRA. Basically you're taking on leverage, which everyone should know, can be financial suicide. In the case of an IRA, you could also do something similar and take out a HELOC for 100k at 5% interest and hopefully compound that at 8% for the next 20 years. Free money without the tax costs. I should also mention after looking at my earlier analysis that I did not normalize the tax hits in the IRA in today's dollars. That makes the IRA case more compelling. I did not also show what your account balance would be in either case. In case 2, even though you paid 50% more in taxes (this is not normalized), you still end up with way more money in the IRA: 699k vs. 466k. I rushed through that analysis before posting it. Sorry. Also, I meant to say Washington, not Oregon, for states with no state income tax. Regardless, if anyone can show me a compelling economic argument for the Roth, I'll bite. Otherwise, staying in my IRA. One reason I converted is that we don't have state income tax (yet) in Washington state, where I live. Considering that most states have income taxes (and we might move some day) and that Washington state may eventually have a state income tax, it was a good time to lock in the zero-tax forever.. Now for the compelling economic argument: Let's say the tax rate is the same today as it would be 30 years from now, and let's say you pay the same percentage today during Roth conversion as you would in 30 years making IRA withdrawals. Okay, now let's say a conversion today would cost you $200k in tax. Well, if you choose not to convert and you manage to compound the $200k at the same after-tax rate as the funds in your IRA, then you may find that conversion didn't accomplish anything. So the question is, how are you going to compound that $200k after-tax at the same rate as the money in your IRA? And if you think you can actually achieve that, then why aren't you employing that strategy in your IRA with your tax-deferred investments? So it's obvious that it's harder to compound the $200k in your taxable account at the same rate as the money in your IRA. That's one of the reason why I converted. The other reasons are: 1) no forced withdrawals after 70.5 yrs age 2) my children can inherit my Roth and leave the money in there compounding tax free. I have a ridiculous sum in there now, and I'm 33 years away from being 70. I do not want to be "surprised" by a 70% tax rate (same as when I was born) if my account grows to $500m or so by then -- in the IRA, the forced withdrawals would be so large they could easily trip such a tax rate. 35% (today's rate) is cheap by comparison.

At Fidelity, choose "Account&Trade" then "UpdateAccounts/Features". Then choose "Margin&Options". Then you want to enable "Purchase of Calls/Puts".

I didn't realize there was no long-term period. I have never actually stayed in put contract longer than 12 months, but always thought the tax treatment was there. Disagree though on the reasoning -- in addition to the cash, the liability is also received on day one. Holding the cash up front eliminates counterparty risk, but does not mean you won't lose your shirt. The capital gain only happens when the liability is lifted... and if the time period is long term, then we get the phrase "long term capital gain". Sucks that the law doesn't actually follow the logic as I see it. I will need to change how I hold this -- move it to my Roth.

I wrote 2012s for tax reasons -- didn't want short term tax penalty.

Yes thanks for posting. I followed him into AIG last week ($45 strike puts for nearly $20) -- they put me up 40% right out of the gate with opportunity for another 28.5%.