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.