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Why You Should Consider Roth Conversions Thumbnail

Why You Should Consider Roth Conversions

Financial Planning Insights Investing Behavioral Finance Retirement Planning Tax Planning

With the stock market down to start the year, there has been a lot of talk on TV and online about the benefits of completing Roth conversions as a financial planning tool.  With the stock market down, you can convert more shares of your investments to a Roth account than you could last year when the market was up.  The only caveat is you must have the cash on hand to pay the taxes upfront or the advantage of completing a Roth conversion is lost.

Many experts are pushing for Roth conversions this year with the stock market down, saying that it is cheaper to convert this year because your account value is lower.  This is partially true, but only if you are converting your whole account at one time.  Most people don’t have the free cash flow to complete a wholesale Roth rollover of their traditional IRA funds.  But this planning tactic can provide you with a great benefit while your accounts are temporarily down.  Here’s an example:

Let’s say you have an IRA with $100,000 in it, in January of this year it was worth $120,000.  If you converted the whole account, you would have $100,000 of extra taxable income and if your tax bracket was 22% you would owe $22,000 in additional federal taxes.  You don’t have the cash flow to convert the whole amount, but you still want to take advantage of a Roth conversion, so you choose to convert a portion of your traditional account.  You choose to convert $20,000 so your extra federal taxes would be $4,400.  The number of shares your $20,000 is worth are higher today than they were in January of this year.  So, by converting when the market is down you can convert more shares to a Roth account for future growth.  If shares of your investment were $100 in January your $20,000 would convert 200 shares, if that same investment is now with $80 per share your $20,000 is converting 250 shares.  For those that can pay the tax with extra cash, this is why completing a Roth conversion makes sense this year.  In fact, if you expect to be in a higher tax bracket in retirement than you are today because of RMDs, planning for a Roth ladder or completing a series of Roth conversions before you are 72 could save you significant money on taxes over your lifetime.

Here’s a quick overview of the Roth IRA.  Unlike the traditional IRA, a Roth account is after-tax money, that grows tax-free, and can be withdrawn tax-free.  It is an integral part of retirement planning, as having a tax-free bucket of money to pull from adds incredible flexibility to your retirement income.  For instance, when you might be up against a higher income bracket, at risk of having more of your Social Security benefits taxed or jumping into a higher Medicare premium bracket you can pull funds from your Roth IRA and not increase your taxable income in any given year.  Your Roth IRA can save you hundreds or maybe even thousands of dollars in tax over your lifetime.

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