November 4, 2022

Roth Conversions in a Down Market

Roth Conversions In A Down Market

As the old cliché says, when life hands you lemons, you need to make lemonade. The market has been sour lately, to say the least. Down markets make Roth IRA conversions more valuable because the inevitable market recovery occurs in the tax-free Roth IRA rather than a taxable traditional IRA.

The first step in utilizing this strategy is determining if a Roth conversion makes sense for you, regardless of market conditions, and how much. In short, if your tax bracket is lower now than your expected tax bracket during retirement, then converting some of your traditional, pre-tax retirement accounts to a tax-free Roth IRA may make sense.

If a Roth conversion does make sense, a market downturn makes the strategy more effective because, for the same “tax budget”, you can convert a higher proportion of your traditional IRA when the account value is down. This allows for a recovery to occur in the Roth IRA, giving you more value for your tax expenditure.

Here’s an example:

John and his financial planner have determined that converting $20,000 of his traditional IRA to Roth IRA makes sense this year. At the beginning of the year, his traditional IRA had a $100,000 balance. If he converts the funds to his Roth IRA at those levels, he will have $80,000 in his traditional IRA and $20,000 in his Roth IRA.

Instead, John converts the same amount from his IRA to his Roth IRA when the market is down 20% and his IRA balance is $80,000. This gives him a Roth IRA balance of $20,000 and a traditional IRA balance of $60,000. When the market rebounds and his total is back to $100,000, John will have $75,000 in his traditional IRA and $25,000 in his Roth IRA. By making the conversion during a market downturn, John has increased the relative value of his Roth conversion by $5,000.

You cannot time the market, whether we’re talking about getting out, getting in, or making a Roth conversion. When it comes to doing a Roth conversion you do not have to be perfect. Additionally, regardless of market downturns, your overall tax situation is the number one determinant of whether a conversion makes sense. But if it does, remember the advantages offered by making the conversion when the market is lousy.

If you are interested in more information about this strategy and would like to talk to a financial adviser, please contact us today.

About Shotwell Rutter Baer

Shotwell Rutter Baer is proud to be an independent, fee-only registered investment advisory firm. This means that we are only compensated by our clients for our knowledge and guidance — not from commissions by selling financial products. Our only motivation is to help you achieve financial freedom and peace of mind. By structuring our business this way we believe that many of the conflicts of interest that plague the financial services industry are eliminated. We work for our clients, period.

Click here to learn about the Strategic Reliable Blueprint, our financial plan process for your future.

Call us at 517-321-4832 for financial and retirement investing advice.