There’s not much fun to be found in a down market, and for much of this year, that’s where the market has been. But there are a couple of silver linings to be found, even when stock and bond prices are in the doldrums. One, of course, is the opportunity to make strategic additions to holdings while the assets are “sale priced.” As Warren Buffett says, wise investors are greedy when others are fearful.
But there’s another upside to a down market. For those considering converting traditional IRAs to Roth IRAs, doing the conversion while account values are down can actually save money on the tax bill, both now and later.
Remember that with a traditional IRA, you aren’t taxed on the money deposited in the account (you get a tax deduction for the deposits). Funds grow tax free until retirement, at which time you pay taxes on withdrawals from the account at the same rate as your ordinary income. Many investors like to leave the funds in the account as long as possible, to take advantage of tax-free compounding and growth, but when you reach age 72, you must begin taking required minimum distributions (RMDs) from the account.
A Roth IRA differs in several respects. First, you don’t get a tax break for depositing into the account. But once in the account, compounding and growth in the assets is shielded from taxation, just as with a traditional IRA. And when you withdraw the funds in retirement, the income is not taxable. In addition, Roth IRAs have no RMDs; you can leave the money in the account as long as you want.
Roth IRAs are especially advantageous for those who believe they will be in a higher tax bracket in retirement than they are presently. This makes sense for many soon-to-be retirees who own their own businesses, as many of the deductions presently available to them may go away when they retire. Paying taxes on the funds now and obtaining tax-free income later—and also the option to leave the funds alone entirely—can be especially attractive if you anticipate a higher bracket in your future.
To convert a traditional IRA to a Roth IRA, you must pay taxes on the converted amount in the tax year when you made the conversion. That’s why it can be to your advantage to make the conversion when account values are lower—as in the current down market.
Another reason to consider Roth conversions now is that tax brackets may be as low as they are going to get for awhile. We already know that the established by the Tax Cuts and Jobs Act (TCJA) of 2017 is set to expire in 2025. And there are other reasons why some analysts expect that taxes may edge up in the future. The lower your tax bracket when you do the conversion, the less you’ll pay in taxes for making the change. So, it may make sense to make the change now, rather than later.
At Empyrion Wealth Management, our recommendations are tailored to the specific needs and situation of each client and always delivered with the client’s best interests foremost. To learn more, click here to read our article, “Your Retirement Income and Your Taxes.”
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