by Robert E. Quittner, Jr. CFP® & CMFC™
Investment Advisor Representative
[email protected]
The extreme market swings we’ve experienced over the last month can be unsettling, and the talk of a potential recession only adds to the pain. As the old saying goes, “Make lemonade out of lemons.” I know, I know…. easier said than done these days. Two different tax strategies to accomplish that are Tax Loss Harvesting and Roth Conversions, but I’m just covering Roth Conversions today.
Roth conversions can be a powerful tax planning strategy—if used wisely. Here’s a breakdown of what they are, the opportunities they present, and when they can be most effective.
A Roth conversion involves moving funds from a Traditional IRA (or other tax-deferred retirement accounts) into a Roth IRA. The converted amount is taxed as ordinary income in the year of conversion. Once inside a Roth IRA, the funds grow tax-free and can be withdrawn tax-free in retirement, assuming you follow the rules.
Why Is a Market Downturn a Golden Opportunity?
When markets fall, the value of your IRA drops. That means:
• You can convert more shares for the same dollar value.
• You’ll pay less tax on the conversion because the account is worth less.
• When the market rebounds, all future growth occurs in a tax-free Roth environment.
Here’s an Example:
Suppose you had $100,000 in a Traditional IRA, and it dropped to $70,000 during a downturn. Converting that $70,000 now means:
• You pay tax on $70,000 instead of $100,000.
• When the account recovers back to $100,000 (or more), all that growth is tax-free inside the Roth.
Why Should You Consider a Roth Conversion?
- Tax-Free Growth & Withdrawals
o Once in a Roth IRA, investments grow tax-free.
o Qualified withdrawals in retirement are not taxed, unlike traditional IRAs. - No Required Minimum Distributions (RMDs)
o Roth IRAs don’t require RMDs during the account holder’s lifetime, giving you more control over your income in retirement.
o Converting enough Traditional IRA monies before your RMD age can lessen or avoid Income-Related Monthly Adjustment Amount (IRMAA) Medicare Part B penalties. - Tax Bracket Optimization
o Ideal in years when your income is lower—convert enough to “fill up” a lower tax bracket without jumping into a higher one. - Legacy Planning
o Heirs can receive tax-free distributions (subject to the 10-year rule for most non-spouse beneficiaries). - Future Tax Rate Hedge
o If you expect tax rates to rise (either personally or legislatively), paying taxes now at a lower rate can be a good hedge.
When Are the Best Times to Do a Roth Conversion?
• After retirement, but before RMDs (usually between ages 60 – RMD Ages of 73/75): people often have lower income during these years, so you can convert at a lower tax rate.
• During a sabbatical or gap year when income is temporarily reduced.
• Early retirement or when temporarily out of work.
Items to Keep in Mind Before Converting
• Immediate tax hit: You’ll owe income tax on the amount you convert. The optimal solution is to pay the tax out of a non-retirement account.
• Impact on Medicare premiums (IRMAA): Higher income from conversions can push up your Part B and D premiums.
• Net Investment Income Tax: Conversions can bump up your Adjusted Gross Income and subject other income to this 3.8% surtax.
If Roth conversions are structured properly, they can save you and your heirs significant tax dollars over your lifetimes. If you’d like us to run a “Roth Conversion Analysis”, we have the tools to illustrate the potential benefits and savings.
Enjoy your weekend!
Rob