Roth IRA Conversions in a Down Market

While many investors saw their account values drop in 2022, there may be a silver lining. Perhaps this is an opportunity to do a Roth Conversion.

First, what’s the difference between a Traditional IRA and a Roth IRA?
Both types of IRAs are designed to help you save for retirement while providing tax-favored treatment. Essentially, the difference is when your funds are taxed: before they go in, or when they come out.

  • Traditional IRA – Contributions are pre-tax, so distributions will be taxed
  • Roth IRA – Contributions are after-tax dollars, so distributions will be tax-free

Roth IRA Conversions in a Down Market

A Roth conversion is where those pre-tax dollars from a Traditional IRA are moved to a Roth IRA to continue to grow. This is taxed in the year you make the conversion, as part of your income. So, while no one likes to see their IRA value decrease, a down market presents a unique opportunity for a Roth conversion. Since you pay tax on any amount converted, you will owe taxes on a smaller amount if you make a conversion during a down market. Plus, the funds that you convert will now be in an account that benefits from tax-free growth.

You may want to consider a Roth Conversion if you:

  • Believe your tax rate will be higher in retirement than it is now – If you haven’t reached your peak earning years, it’s possible that you could be in a higher tax bracket in retirement.
  • Want to minimize the tax burden for your heirs – If you don’t expect to use much of your IRA and anticipate that your children will be in a high tax bracket when they inherit, they could benefit from the account being tax-free.
  • Have irregular income and expect it to be lower this year – For example, if you own a business that’s generating a net loss for the year, this may be a perfect opportunity to make a Roth conversion and owe less in taxes.
  • Are lacking diversity when it comes to tax treatment in your retirement accounts – If most of your assets are in pre-tax accounts, you would pay income tax on every distribution in retirement. A tax-free portion of assets could give you greater flexibility to stay out of higher tax brackets in retirement.

As with many financial strategies, the Roth conversion isn’t one-size-fits-all, but it could provide substantial benefits for the right scenario. We have the tools and expertise to help you sort through this decision. Please contact us if you’d like to see if this is a good time for you to consider a Roth conversion.

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