Should you consider a Roth conversion while the market is down?

While a bear market may not be a fun time for investors, there are some bright spots and opportunities to be seized. Stock market crashes like the ones we’ve seen recently could make a Roth IRA conversion more attractive as a strategy to investors.

Should you consider converting a traditional IRA to a Roth during a down market? There are a few things to consider before you pull the trigger.

What is a Roth conversion?

Before embarking on a Roth conversion, you need to fully understand what it is all about. When you have a traditional IRA, those are pre-tax dollars that you are investing. Even though money grows tax-free, when you make a withdrawal later, every dollar you take out is taxable.

With a Roth IRA, you’re investing after-tax dollars, and when you convert a traditional IRA to a Roth, you pay full tax during the year you convert, at ordinary income rates. The dollars you’ve converted will then grow tax-free for the rest of the time they remain within the investment. When you later take money out of a Roth, it’s all tax-free, as long as you’re age 59 1/2 or older and follow a few other rules.

What you need to know about a Roth conversion in a falling market

When you activate a Roth conversion, you will be responsible for paying the tax due on any pre-tax contributions or earnings within the traditional IRA. The benefit here is that if the market is down, chances are the value of your IRA has gone down along with it, so your total value has gone down, and you’ll pay taxes on the current value (which is lower, due to the market is lower than it was months ago). So, in theory, you can convert a larger portion of your IRA in a down market and pay less tax than you would in up market years.

Here’s an example: If you had a traditional IRA with $100,000 at the beginning of the year and, due to the market, it’s now down to $85,000, you could choose to convert that entire IRA to a Roth account and only pay taxes on the $85,000. instead of the $100,000 it was months ago. Assuming that these dollars will recover in the market in the future, you have chosen a good opportunity to convert.

It’s important to work with both a financial advisor and your tax professional to determine not only how much tax you’ll owe during the year you do the Roth conversion, but also how long it would take you to break even.

What are the advantages of a Roth conversion?

Converting from a traditional IRA to a Roth has many potential benefits for investors. Because a Roth IRA allows dollars to grow tax-free, all growth is also tax-free. There are also no RMDs, or required minimum distributions, in a Roth IRA once you turn 72. With a traditional IRA or 401(k), you have a set minimum that you must withdraw each year once you reach RMD age, but Roth IRAs do. not comply with this rule.

Tax rates are still relatively low, historically, which means now is a good time for a Roth conversion, from a tax perspective. Tax parity is another benefit of Roth IRAs because you have different “buckets” of income to withdraw in an effort to keep your taxes low in retirement. Roth IRAs also benefit your spouse and heirs at the time of inheritance, as the tax-free benefits are transferred to them in a variety of ways, depending on the time limit and amount, and their relationship to you, the decedent. .

Some cautions about conversions

However, Roth IRA conversions aren’t all benefits, there are a few things to keep in mind. There is the five-year rule, where you have to wait five years after a conversion before making a withdrawal or else you could incur a 10% penalty. Note that this five-year rule only applies to those under the age of 59½. After reaching that age, the five-year rule and its penalties no longer apply.

Activating a Roth conversion can also increase your adjusted gross income (AGI), which could compound other problems, such as Medicare premiums. This can also increase your tax rate.

The best way to determine if a Roth conversion is the right decision for you during a down market is to work with a financial advisor and tax professional so you can get input on your specific financial situation.

Diversified, LLC does not provide tax advice and should not be relied upon for purposes of tax reporting, estimating tax liabilities, or evasion of taxes or penalties imposed by law. Information provided by Diversified, LLC should not be a substitute for consulting a qualified tax advisor, accountant, or other professional regarding the application of tax law or an individual tax situation.
Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information on the tax consequences of investments. Investments in securities carry risks and are not suitable for all investors. This site is not a recommendation or an offer to sell (or the solicitation of an offer to buy) securities in the United States or any other jurisdiction.

President, Partner and Financial Advisor, Diversified, LLC

In March 2010, Andrew Rosen joined Diversified, bringing with him nine years of experience in the financial industry. As a financial planner, Andrew builds lifelong relationships with clients, providing guidance through all stages of life. He has earned his Series 6, 7 and 63, along with property/casualty and health/life insurance licenses.

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