In 1975, both Mitt Romney's business career and individual retirement accounts were launched. Back then, the maximum IRA contribution was $1,500 a year; in 2012 you might put in as much as $6,000. So how did Romney famously accumulate over $100 million in his IRA, as has been reported?

The short answer is, he probably didn't. On his federal financial disclosure report, Romney valued his IRA between $20.7 million and $101.6 million. Thus, despite all the attention paid to his "$100 million IRA," Romney might have a mere $21 million or so in his retirement account. Indeed, a precise valuation could be difficult if Romney's IRA holds interests in private companies, as seems likely.

Still, going from $1,500 or $2,000 or even $6,000 a year to an eight-figure IRA is impressive, and Romney obviously didn't do it with four-figure deposits. "You accumulate that much in an IRA in two ways," says Mary Kay Foss, a director with the accounting firm Sweeney Kovar in Danville, Calif. "Those are rollovers from qualified plans and successful investing in the IRA."

Romney probably did both, but not in that order. He was at Bain Capital through 1999, participating in the company plan, where annual contribution limits were as high as $30,000. Bain is a venture capital firm that prospered in the bull market of the 1980s and 1990s, and Romney loaded up his qualified plan with interests in nascent companies backed by Bain. Eventually, he rolled his account balance into an IRA.

Non-Conventional Assets
Thus, one lesson to draw from Mitt Romney's IRA is that clients, especially ultra-high-net-worth clients, needn't stick with mainstream stocks and bonds and mutual funds for IRA investments. With few exceptions, such as shares of S corporations, IRA owners can put their money virtually anywhere. Non-conventional IRA investments may deliver superior results for very wealthy clients who have access to exceptional opportunities, such as Romney had, or who are knowledgeable about specific assets such as real estate.

"Bain was one of the first companies with the management expertise and capital to fund early stage companies," says Foss. "Many venture capital funds will distribute the shares of companies they invest in or the proceeds from a sale, so investors have more funds to put into the next deal." Reportedly, returns for Bain investors averaged 50% to 80% annually.

Now, if Romney had been a real estate developer who tucked La Jolla and Marco Island properties into his IRA in the last quarter of the 20th century, that might have been relatively straightforward. However, he was a venture capitalist who wanted promising private companies for his retirement fund, which raised at least two not-so-straightforward issues.

First, how do you value shares of a private company when they're placed into an IRA? That's never easy, and tactics used by Bain further complicated the issue. Its portfolio companies were given two share classes: A and L. The L shares were the safest, accruing interest at 10% or higher in some cases, and getting first dibs on liquidation proceeds. The A shares were riskier, behind the L shares for getting money, but entitled to most of any gains after the L share holders got their due.

Bain had flexibility in assigning values to these share classes. Pointing to the higher risks, the A shares were valued much lower than the L shares. Anyone who put the low-valued A shares into the company plan could contribute many shares, up to the $30,000 limit. The payoff for success would be greater, too. In some Bain deals, the A shares reportedly enjoyed gains for more then 30 to 1 while L shares doubled. It's true that holding the speculative L shares in a retirement fund wastes the opportunity for low-taxed capital gains, but this practice also avoids having to pay tax every time profits are realized and reinvested.

In some early Bain deals, the L shares were valued at nine times the A-share value; recently, Bain has used a 4 to 1 ratio, which would decrease the profit potential of the A shares. Going forward, clients in similar situations should be sure that the valuations of illiquid IRA assets are handled professionally, but being aggressive might make sense. "I've seen the IRS challenge valuations of private companies in estate tax situations, but not when it comes to lifetime IRA valuations," says IRA expert Ed Slott, a CPA based in Rockville Centre, N.Y.

Second, because of the nature of his IRA investments, Romney had to wrestle with unrelated business taxable income and unrelated debt-financed income, which leaves him subject to payment of unrelated business income tax even though it is supposedly a tax-deferred retirement plan.

According to Bob Gordon, president of Twenty-first Securities Corp. in New York, the potential tax problem in Romney's IRA stems from the heavy use of leverage in Bain's private equity deals. "If you invest IRA money in General Motors," he says, "and GM uses leverage, that's not going to result in UBIT. However, Romney invested IRA money in Bain partnerships, and partnerships are pass-through entities, so effectively the IRA was using leverage, which would expose it to UBIT." The UBIT tax on retirement accounts is assessed at trust tax rates, meaning that the top 35% rate kicks in after $11,650 of income in 2012.

The same issue arises for many tax-exempt charities, universities, pension plans, etc. Accordingly, so-called "foreign blockers" and "offshore blockers" have been created to block the payment of UBIT. If a tax-exempt entity invests in this type of corporation, which in turn will invest in the leveraged partnership or other UBIT producer, UBIT can be avoided.

Clients who invest IRA money in hedge funds also may want to use such blockers, which are usually based in tax havens to avoid corporate tax, says Gordon. "Most hedge funds have a domestic fund and an offshore fund," he points out. "Offshore funds historically have been for U.S. tax-exempts and non-U.S. entities. U.S. tax-exempts such as pension plans and foundations try to avoid UBIT by investing in the offshore fund." Similarly, an IRA investing in a hedge fund that uses a pass-through structure and leverage (both usually the case) may be better off in the offshore version.

Creditor Risk
Such maneuvers helped Romney build a large IRA while stiff-arming the IRS. However, he may have made some misjudgments along the way. Rolling over the money from the Bain plan to an IRA might come back to haunt him, for instance.

"Assuming Romney's IRA was rolled over from a qualified plan of Bain Capital, he may have walked away from substantial creditor protection," says Michael J. Jones of Thompson Jones LLP, a tax consulting firm in Monterey, Calif. "ERISA-covered plan accounts enjoy creditor protection without limit. Also, if there was insurance on Romney's life in the employer plan account, that could not have been rolled over because IRAs can't own life insurance."

Bob Keebler, who heads a tax advisory firm in Green Bay, Wis., notes that creditor protection is especially vital for some clients. "Architectural and engineering professionals, for example, have very long 'tails' for malpractice liability," he says, "so they may want to keep their money in the company plan, which often will be permitted. Creditor protection for IRAs usually is not as extensive as it is for company plans, but that varies from state to state. I'd suggest a client with a large retirement account speak with expert ERISA counsel before executing an IRA rollover."

Is it too late to regain lost creditor protection? Perhaps not. "Romney could have started another business, set up a plan for that business, and rolled over his IRA into that plan," says Jones. "However, the new plan would have to be covered by ERISA to provide ERISA creditor protection. A plan that only covers Romney, or only Romney and his wife, won't help."
Moreover, Romney apparently holds a traditional IRA. That would have been expected through 2009, when IRA owners with income over $100,000 couldn't convert to a Roth IRA. Starting in 2010, though, Roth IRA conversions have been universally available, regardless of income.

"For IRA owners, including those with large accounts, a conversion before year-end can be a good idea," says Slott. "Income tax rates may be higher next year, perhaps much higher, and who knows how high tax rates in the future might be."

With a traditional IRA, all pretax dollars must be withdrawn as taxable income by the account owner or by future beneficiaries. Romney is 65, so in a few years (after 70½) he'll have to start taking required minimum distributions (RMDs). Assuming he has a $25 million IRA at that point, he'd have to take out around $1 million in year one and pay the required income tax. After a Roth IRA conversion, he would never have RMDs.

"Roth IRA conversions never looked so good as they do now," says Jones. Not only will 2012 conversions be taxed at rates no higher than 35%, today's slow economy may lead to a legitimately low valuation of illiquid IRA assets-and a relatively low tax bill. "IRAs must be valued each year," says Slott. "If a client is reporting a low value because of the weak economy, less tax will be due on a Roth IRA conversion."

Paying the tax from non-IRA investment assets can trim a client's taxable holdings, reduce future taxable investment income, and therefore reduce exposure to scheduled tax hikes as well as to the coming 3.8% Medicare surtax. After five years and after age 59½, all Roth IRA withdrawals will be tax-free. In essence, a Roth IRA conversion this year can move mega-IRA money from surtax straits into tax-free territory.