Wealth Planning Opportunity in a Bear Market

Roth IRA Conversions: Low Stock Prices Mean More Potential Tax Savings

While it can be unnerving to witness the sharp declines in global equity markets caused by the coronavirus pandemic and the uncertainty it creates, there is a bright spot and what could be a potential opportunity for long term wealth planning. Current market volatility is creating an attractive environment for Roth IRA conversions. A Roth IRA conversion allows investors to transfer all or some of their traditional IRA assets to a Roth IRA. Doing so now can save IRA owners income taxes while rates are low and market prices are down.

There are three main reasons why an individual may want to consider a Roth IRA conversion:

  1. As a means of reducing future required minimum distributions – RMDs – beginning at age 72 (The SECURE Retirement Bill – Withum Wealth),
  2. To transfer assets to non-spousal beneficiaries at death more efficiently than a traditional IRA, and
  3. To further diversify the tax characteristics of an investment portfolio as qualified withdrawals from the Roth IRA are tax-free.

While the strategy has its benefits, converting to a Roth IRA in any given year can be an expensive proposition and may not prove to be the most appropriate decision for all taxpayers. When making the conversion, traditional IRA owners pay tax on the dollar amount converted, or transferred, to a Roth IRA at prevailing ordinary income tax rates. This income is added to any other taxable income generated by the taxpayer in that year. Those who choose to convert are essentially buying out the government’s share of the IRA now rather than waiting until the IRS forces a taxable required minimum distribution. Investors should determine if they have enough assets outside the IRA from which to pay the tax resulting from the conversion. It doesn’t make sense to pay the tax using IRA assets as it reduces the dollar value of the funds moving into the Roth IRA.

Considering a Roth IRA conversion now could mean a lower tax bill. For instance, an investor with a traditional IRA worth $350,000 invested in global equities might have seen her portfolio drop by $90,000. A decision to convert the IRA now rather than a few weeks ago, can save her almost $50,000 in taxes by moving her into a lower tax bracket.

All future gains are shifted to the Roth IRA, a retirement account that is not subject to any future distribution requirements. Reducing future taxable income can help retirees save money on Medicare premiums and taxes on Social Security benefits.

When deciding whether to implement a Roth conversion, an investor should make sure that it fits in their financial plan, including any estate planning considerations. Just because the market is lower doesn’t mean this strategy is right for everyone. IRA owners should consult with their tax advisor prior to implementing a Roth conversion. If you would like to learn more, or for any questions related to this strategy, please contact your advisor at Withum Wealth Management.

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