Roth Conversions in Down Markets

While no investor would like to see down markets, they are unfortunately an unavoidable part of the ­­market cycle. In periods of prolonged down markets, it is easy to focus on your declining portfolio balance rather than seeking opportunities in other areas of your encompassing financial plan. A weak market like we have experienced year-to-date can create opportunit­­ies for several tax strategies such as tax-loss harvesting and Roth conversions. We want to discuss how individuals like you can reap the most benefit from completing ‘discounted’ Roth conversions.

Roth IRAs were created in 1997 and have been an increasingly popular retirement savings vehicle since their inception. Unlike pre-tax accounts participating in tax-deferred growth, meaning you pay taxes when the funds leave the account, Roth IRAs participate in tax-free growth, creating opportunity for tax-free distributions throughout retirement. Roth IRAs are also not subject to required minimum distributions (RMDs), which traditional pre-tax assets will be subject to beginning at age 72.

The annual contribution limit to a Roth IRA is 6,000 plus the age-50 and older catch-up contribution of $1,000. However, some employers' 401(k) plans allow for Roth 401(k) contributions up to the annual limit of $20,500 plus a catch-up contribution of $6,500. Another avenue for funding a Roth IRA account is participating in a structured Roth Conversion plan.

A Roth conversion is simply a transfer of assets from a pre-tax account to a Roth account. This conversion creates an ordinary income taxable event in the year it is executed. Roth conversions can be utilized for lifetime tax planning through participating in future tax-free growth and limiting RMD payments later in retirement.

When portfolio balances decline, it essentially creates an opportunity for investors to convert a more significant percentage of their pre-tax assets to Roth. The recent decline in the market effectively puts Roth conversions at a ‘discount.’ It offers an excellent opportunity for investors to position themselves for increased tax-free growth as markets recover.

Certain factors will help determine when a Roth conversion is ideal. As discussed above, down markets create an environment where Roth conversions are at a ‘discount,’ but this is not the only factor investors must consider in determining if a Roth conversion is right for them. Other factors to consider include:

  • current tax rates, future tax rates
  • the pro-rata rule
  • the five-year rule
  • current cash flow requirements
    and others.

Our CPAs and CFP® professionals are happy to conduct an in-depth Roth Conversion and RMD analysis based on your current and future situation.