Is A Down Market The Right Time For A Roth Conversion?
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While a down market may be cause for concern for some, it’s an opportunity waiting for others. One such opportunity may be a Roth IRA conversion. Is a down market the right time for a Roth IRA conversion for you?

What’s The Difference Between A Roth And Traditional IRA?

Before you decide to convert a traditional IRA to a Roth, it’s important to understand the differences between a Roth and traditional IRA. Both types of IRAs are designed to help you save for retirement while providing a tax advantage, but they do so in different ways. With a traditional IRA, you pay the tax due on the withdrawal amount and with a Roth IRA, you pay a tax on your contribution amount so that the withdrawal amount later is tax-free.

When you initiate a conversion, you take your traditional IRA, where you’ve been investing pre-tax dollars, and convert it into a Roth IRA, where you’ll invest those dollars tax-free so that they can grow, and you can withdraw them in the future tax-free. Going from a pre-tax to tax-free investment means that you’ll need to pay the full tax due during the year that you make the conversion, at ordinary income rates.

There are several things to consider before embarking on a Roth IRA conversion at any point but especially during a time when the market is down.

Roth IRA Conversions In A Down Market

Since you are responsible for paying tax on any pre-tax contributions or earnings that have already been contributed to your traditional IRA when you go through with a Roth IRA conversion, there are some key benefits to having the conversion take place during a down market. When the market is down, it’s likely that your IRA value has also decreased. While this might seem like a bad thing, when it comes to paying taxes on that amount, it means that you’ll have a lower tax bill. If you convert a traditional IRA to a Roth in a year when the market is down, you’ll theoretically be paying tax on a lower amount of assets, and then those assets can recover in the market, and you can later withdraw them tax-free.

It may help to assign values so you can clearly picture the scenario. If you had a traditional IRA with $100,000 at the start of the year and due to the market conditions, that IRA is now worth $75,000, you might choose to convert your traditional IRA to a Roth and only pay tax on the $75,000 instead of the $100,000 you had at the beginning of the year when the market was stronger. If those same dollars rebound long-term in the market, and you allow them to grow tax-free in a Roth, you’ve picked a good opportunity to convert from a traditional IRA to a Roth.

There are additional benefits to a Roth conversion that don’t rely on your market timing. With a Roth IRA, there are no RMDs as there are with traditional IRAs or 401(k)s. From a tax perspective, tax rates are still relatively low, historically speaking, so now is as good of a time as any to convert from a traditional to a Roth. A Roth IRA may also benefit your heirs or spouse at inheritance time, as the tax-free benefits may pass along to them depending on the time limit and amounts, and their relationship to you.

Before You Convert A Traditional IRA To A Roth

There are a few things you need to keep in mind before converting your traditional IRA to a Roth. The five-year rule, for example, locks you into waiting five years before making a withdraw after the conversion or else you’ll face a 10% penalty. You also need to monitor your adjusted gross income as triggering a conversion may increase your AGI, which can increase both your tax rate and cause your Medicare premiums to change.

How can you tell if now is the right time to convert your traditional IRA to a Roth? Talk with both a financial advisor and a tax professional so you can understand your own specific financial and tax situation, to learn how a conversion might impact or benefit you.

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