With the recent volatility and market downturns, your portfolio may not be as robust as it once was. But not all is lost. It may be time to think about converting a portion of your Traditional IRA into a Roth IRA, especially if you’ve been considering this option for quite some time. But what is a Roth IRA?
A Roth IRA is:
- A tax-advantaged individual retirement account to which you can contribute after-tax dollars.
- In this account, your earnings and contributions can grow tax-free.
- Once an account has been opened for 5 years, when you reach the age 59½, you can withdraw funds penalty-free
A Roth conversion is when you move assets from qualified accounts, such as a Traditional IRA or an employer sponsored retirement plan such as a 401(k), 403(b) or even a 457(b) to a Roth IRA. There can be benefits to a Roth conversion with the current market being down. Traditional IRAs allow for tax-deferred growth meaning your tax responsibilities would be addressed upon distribution of your assets.
Example
You have 150K in a qualified individual retirement account, but the down market has reduced that amount to $90K. You can now take that 90K and convert to it to a Roth IRA, paying the up-front taxes on that lower amount. Once the market ticks back up, your 90K returns to its former glory of 150K and more, and you avoided paying taxes on that larger amount.
While the opportunity to pay less taxes upon this conversion are available, it’s worth noting that moving from a qualified account to a Roth IRA could come with other tax consequences. Also, while everyone who have IRA assets qualifies for a Roth conversion, not everyone will qualify for a Roth Contribution on its own because of income restrictions. Make sure you understand the qualification terms before proceeding.
A Roth conversion may make sense if you:
- Will not need to convert Roth funds for at least 5 years.
- Expect your tax bracket to remain the same or increase during retirement.
- Able to pay the taxes on the conversion without dipping into your retirement funds.
- Will not need the funds and anticipate transferring the distribution to your beneficiaries.
There are also many reasons why a Roth conversion may not be right for you. Before deciding about a Roth conversion, you should consider your current and future tax situation, the availability of funds and assets available to pay your income taxes and your time horizon. It’s important to speak with a tax-professional to answer any lingering questions you make have about any tax consequences deriving from a Roth conversion.
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