Retirement Savings in a Volatile Market - Is Now the Time for a Roth IRA Conversion? | Ed Slott and Company, LLC

Retirement Savings in a Volatile Market - Is Now the Time for a Roth IRA Conversion?

By Sarah Brenner, JD
IRA Analyst
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The coronavirus has been wreaking havoc on markets and millions of retirement account balances have suffered significant losses. This has left many IRA owners looking at lower account balances after several years of gains and wondering what the next step should be. One strategy to consider in a market downturn is a Roth IRA conversion.

Why Convert Now?

When you convert your traditional IRA to a Roth IRA, your pretax traditional IRA funds will be included in your income in the year of the conversion.  This increased income may impact deductions, credits, exemptions, phase-outs, the taxation of your social security benefits and Medicare Part B and Part D premiums; in other words, anything on your tax return impacted by an increase in your income.

That is a tax hit, for sure, but keep it in perspective. Remember, the extra income is only for the year of the conversion. The trade-off is the big tax benefit down the road. If you follow the rules for qualified Roth IRA distributions, all your Roth IRA funds, including the earnings, will be tax-free when distributed. Not a bad deal!

A Roth IRA conversion done when the market is down is a bargain. Remember, your tax bill is based on the value of the traditional IRA assets at the time they are converted to a Roth IRA. Convert now when values are low and reap the benefits of tax-free earnings later when the market bounces back.

Beyond the volatile markets there are other good reasons to convert now. Tax reform has lowered tax rates for many and scaled back the AMT. These historically low tax rates will not be here forever. There is a window of opportunity to take advantage of them. Like many of the changes under tax reform, they are scheduled to sunset in a few years. No one knows for sure what the future will bring, but with large deficits a likely possibility, many see future tax rates as moving much higher. Converting now is a way to lock in today’s low rates and avoid worries about the uncertainty of future taxes.

Thinking conversion may be the right move? Ask yourself three questions. First, when will the money be needed? If you need your IRA money immediately for living expenses, converting may not be for you. Second, what is your tax rate? If your income is lower, that may favor conversion. Third, do you have the money to pay the tax on the conversion? It is best to pay the conversion tax from non-IRA funds.

Not sure about converting? The good news is that conversion is not an all-or-nothing decision. You can always hedge your bets and do a partial conversion of your traditional IRA.

Is Conversion Right for You?

Should everybody convert? No, of course not. Conversion is not one size fits all. Also, remember that conversions are now irrevocable. There is no more recharacterization or the ability to undo a conversion. This means you must be very sure before you go ahead with the transaction. Are you a good candidate? Is now the time for your conversion? Professional advice is more valuable than ever. The best way to find out what is right for you is to discuss conversion options with a knowledgeable financial or tax advisor.

 


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