Is now a good time to do a Roth IRA conversion?

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Hello, and welcome to Financial Face-off, a MarketWatch column where we help you assess your financial decisions. Our columnist will give his verdict. Tell us if you think you’re right in the comments. And please share your suggestions for future financial face-to-face columns.

Markets have plummeted, with the S&P 500 SPX,
recently in bear territory and the Dow Jones Industrial Average DJIA,
9% drop this year from this writing. But if you have savings in a traditional individual retirement account, there may be a potential benefit to losing all that value. Depending on your individual financial situation, market crashes like this can create the ideal conditions for a Roth IRA conversion, when you move money from a traditional IRA to a Roth IRA.

Now is a good time to do a Roth IRA conversion, isn’t it?

Why it matters

A Roth IRA represents a rarity in U.S. tax law. “There are very few cases in the tax code where you can invest in something that will grow and be tax-free when you take it out,” Greg Plechner, partner and wealth manager at Greenspring Advisors told Paramus. , NJ

Traditional IRAs are funded with “pre-tax” dollars, meaning you don’t have to pay taxes on the money you earn in an IRA in the year you contribute the money. But you will have to pay taxes on your withdrawals from a traditional IRA, which you will have to do from the age of 72.

With a Roth IRA, however, you pay taxes on your money when you deposit it into your account, and you don’t have to pay taxes when you start withdrawing it from your account if you follow the rules. You can start withdrawing the amount you have contributed to a Roth IRA (but not investment earnings or conversions) at any time, but there are penalties and taxes if you do so within five years of creating the account and before you turn 59 and a half. (There are exceptions if you use the money to buy a first home or have a child).

Turning a traditional IRA into a Roth IRA makes sense if you anticipate that your personal tax rates will increase in the future. A Roth conversion is attractive when markets are falling, because if your account has lost value, you’ll pay less conversion tax. The value will recover over time (hopefully) and this growth will be tax free.

“Let’s say you had $ 100,000 in a stock-invested IRA. It’s now down to $ 80,000. If you can move that $ 80,000 to a Roth, you’ll only pay $ 80,000 in taxes and then move it to a Roth where it’s expected to be to grow back to $ 100,000 or more, which would mean totally tax-free growth, ”Grant said. Meyer, a certified financial planner and founder of GTS Financial in Bloomington, Minnesota.

Which makes it important: the money you take out of your traditional IRA and turn it into a Roth is subject to tax. Appears as income on the front page of your tax return. This extra income can have serious financial consequences, such as pushing you to a higher tax level. If you receive Social Security retirement benefits, you can effectively reduce your benefits by potentially increasing your taxable income. If you are of Medicare age, additional income may increase your monthly surcharge in addition to your Medicare Part B premiums. Additional income may also expose you to the 3.8% Medicare surcharge paid by seniors.

Given these possible nasty side effects, when it comes to Roth conversions, “small is your friend,” Plechner says. “Don’t go crazy.” A prudent strategy is to do a partial conversion. Watch out for which tax bracket you’re dealing with with a technique called “bracketing,” he suggested.

The verdict

It depends on your situation, but given the fall in the market, it seems like a good time to firmly consider a Roth conversion.

This is especially true if you are in what Meyer calls “the holy grail.” By that, it means someone with a low income and therefore at a lower tax level, has enough cash to pay the conversion tax bill and has received a few hits in the markets.

Suppose you are a young person who amassed some cash due to stimulus payments and invested heavily in technology because it was going well. “There are probably a lot of people so the wallets are down,” Meyer said.

“They’re a great candidate” for a Roth conversion, he said, mostly because if they’re younger, they shouldn’t have to worry about the potential consequences of Social Security and Medicare. Early retirees, people who have lost their jobs or at least part of their income or workers who have retired from the labor market for a year can also be good candidates, as their income is theoretically lower.

My reasons

While we can’t predict future tax rates, there is evidence to suggest that they will increase, making a Roth conversion even more attractive. Tax rates are at an all-time low, there seems to be a greater desire to tax the richest and many of the lowest rates created by the Tax and Jobs Cuts Act of 2017 will expire in 2025. “I think easily “We could see some kind of tax increase from the tax rate to higher levels,” Meyer said.

Is my verdict the best for you?

On the other hand, if you are in the first three tranches of marginal taxes, the benefits of a Roth conversion are reduced, Plechner said. “If you earn more than $ 170,000 and you’re single, you’re in the 32% group now. That’s my upper limit of where I’d feel comfortable doing a Roth conversion.”

Another factor to consider is what state you live in, Plechner says. If you are in New York and plan to move to Florida, where there is no state income tax, wait until you are in Florida to make a Roth conversion and you may skip paying your bill. state tax.

Here’s another big caveat: Roth conversions are irreversible (this has been the case since the Tax Cuts and Jobs Act came into force). If you get really aggressive and convert $ 100,000 and the tax bill arrives in April and you have no money, you’re stuck, Meyer said.

“Once you do that, you can’t go back,” Meyer said. “That’s why it’s essential to do your homework in advance because there’s no change to undo.” Do not follow this path unless you are clear about your income for the year and what tax bracket you are in.

Tell us in the comments what option you should win in this financial confrontation. If you have any ideas for future financial face-to-face columns, please email me.

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