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Is a down market cycle the time to convert your traditional IRA to a Roth IRA?

Is a down market cycle the time to convert your traditional IRA to a Roth IRA?

June 14, 2022

Due to the recent market volatility, declines in account values, and the ordinary income tax rates still relatively low, now may be the time to consider converting your traditional IRA to a Roth IRA.


When you have a traditional IRA, you invested pre-tax dollars that grow tax-free. However, when you withdraw from your traditional IRA, you are taxed on every dollar withdrawn at the ordinary income tax rate at the time of withdrawal, plus a 10% penalty if withdrawn prior to age 59 1/2. Also, with a traditional IRA, when you attain age 72, you are required to start withdrawing your required minimum distribution and pay tax on the distribution, whether you need the money or not.


When you invest in a Roth IRA, you are investing after-tax dollars which then grow tax-free. With a Roth IRA, withdrawals in retirement are tax-free. Also, you are not subject to the RMD rules.


With a conversion of your traditional IRA into a Roth IRA, you will pay income tax at the ordinary tax rates in the year of conversion on your pre-tax contributions. Then, the amount converted will grow tax-free within the Roth IRA, and withdrawals, when taken, are tax free as long as you are 59 1/2 and follow a few other rules. 


The benefit of converting a traditional IRA to a Roth in a down market is that you will pay tax on the value of your traditional IRA at the time of the conversion. For example, if you have a traditional IRA of $100,000 at the beginning of the year that is now worth $85,000. If you convert the traditional IRA to a Roth IRA when the account value is $85,000, you will only pay tax on $85,000. If the account value rebounds back to $100,000, you've paid the tax on only $85,000. If you did not convert, you will pay tax on the full $100,000 at the current ordinary tax rates when withdrawn from a traditional IRA.


Roth IRA conversions are not all benefits though, there are a few considerations to be aware of.  A Roth Conversion will increase your adjusted gross income in the year of conversion, which could affect your Medicare premiums and put you in a higher tax bracket in the year of conversion. Also, if you are younger than age 59 1/2, you must wait five years after the conversion before making a withdrawal. A portion of the withdrawal may be subject to income tax, and you may incur a 10% penalty. Note that after you reach age 59 1/2, the five-year rule and penalties will no longer apply.


Converting from a traditional IRA to a Roth IRA has many potential benefits. Call (708) 424-4100, email me or schedule an appointment to start the conversation to determine if a Roth Conversion is right for you.