A Silver Lining on a Dark Market Cloud
Perhaps you have heard the saying that even on the darkest day, the sun is still shining. With the recent volatility in the stock market, you would be forgiven for not seeing the silver lining in this otherwise dark cloud. That is, a downturn in the stock market makes Roth conversions even better.
What is a Roth Conversion?
A Roth conversion happens when an investor pays taxes on a tax deferred account in order to move the assets into a Roth account. Let’s say you have $20,000 in a traditional IRA or pretax 401(k). You have not yet paid taxes on the money in that account, and your balance is growing tax deferred, meaning you don’t have to pay taxes on it as it grows. However, when you do draw money out of that account, it will be taxable as ordinary income.
But if that account was a Roth account, it would grow tax free, and after 59.5 years old (and 5 years from first contribution), you could take tax free distributions. Wouldn’t that be great! But how can you do that?
You could convert some of that balance, let’s say $10,000, by reporting it as income this year, paying income taxes on it, and “converting” it to Roth. If you are in the 22% tax bracket, you would pay $2,200 additional income taxes this year. Your $10,000 would then be “converted” to Roth and never again be subject to income tax.
Where’s the Silver Lining?
So, what is so great about the current market downturn? When you convert an IRA or 401(k), you are converting an asset. Your account has mutual funds, ETFs, stocks, bonds, or other assets that have a current asset value. Imagine your $20,000 account consisted of 200 shares of an ETF that had a value of $100 per share. If you convert $10,000, you would be moving 100 shares from pretax to Roth for a cost of $2,200 or $22 per share.
Now imagine the stock market lost 20% and each share of your ETF was now worth $80. That same $2,200 tax cost for the year would convert 125 shares at a cost of $17.60 per share. Or, if you wanted to convert the same number of shares (100), the tax cost would only be $1,760 or $17.60 per share. The lower price per share means you can convert more shares, at a time when the market is down and likely to enjoy a rebound, or you can convert the same amount for a lower tax cost.
To Convert or Not Convert?
Ultimately the question of whether to do a Roth conversion is a tax strategy question. There are a lot of variables to consider including your age, and your current and future tax rate. If you would like to discuss the Roth conversion, reach out to your financial planner to discuss your individual situation.
Did You Know?
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Your financial planner will help you set priorities and achieve your money goals, without judgment or financial jargon. Know that all discussions are kept strictly confidential. This service is offered as an employee benefit with no per-session co-pays, so you can meet with a financial planner as often as you wish. Services are paid by your retirement plan or your employer.
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- Visit FrancisWay.com > Services > Participant Portal
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