Why now might be a good time to convert your IRA to a Roth

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The market may be down right now, but so is the price of converting to Roth.


Key points

  • Unlock tax-free growth using a Roth conversion.
  • The market is discounted, as is the price of a Roth conversion.
  • Always consult with a tax expert before making a conversion.

A well-diversified retirement plan needs more than just a variety of investments. Investors should also consider how savings will be taxed when withdrawn in retirement. Most Americans are saving for retirement on a pre-tax basis, but retirement income should also include some after-tax or Roth savings. Fortunately, Roth conversions are available to many people with IRAs, which could reduce your tax bills by thousands of dollars in retirement. Read on to learn more about what Roth conversions are and why now is one of the best times to act.

What is a Roth conversion?

Basically, a Roth conversion allows you to switch from a pre-tax IRA to a Roth IRA, even if your income exceeds the Roth IRA income limits. By converting a traditional account to a Roth, income taxes can be paid in advance today for tax-free income in retirement. This strategy works in two ways, as Roth IRAs are not subject to Required Minimum Distributions (RMDs).

Here’s a simple example: Imagine you want to convert $50,000 of pre-tax contributions from your traditional IRA to a Roth IRA. You would recognize the $50,000 as gross income, which may be fully or partially taxed at your marginal tax rate. At retirement, the Roth IRA balance, including the $50,000 and any profitwould not be subject to tax or RMD.

Why do a Roth conversion? It all comes down to future taxes. If you expect to be in a higher tax bracket when you retire than you currently are, paying taxes early through a Roth conversion may be attractive. You may be in a higher tax bracket for a number of reasons, including significant income recognition due to high savings rates or increased tax brackets by Congress. Tax rates are constantly changing and current rates are relatively low compared to the last 90 years. In addition, the advance payment of taxes on an investment account in exchange for tax-free growth is a very attractive feature of a Roth IRA.

Ready to open a Roth IRA? Check out our best Roth IRAs of 2022.

What is happening in the market?

It is no secret that the market is not doing very well at the moment. Since the beginning of the year, stock prices have fallen sharply across a wide range of industries. Bond prices, traditionally believed to thwart equity movement, have also underperformed in response to a high interest rate environment. Simply put, the market is doing poorly, regardless of whether you’re an equity investor, a debt holder, or have a bit of both in a diversified portfolio.

Is now the right time for a Roth conversion?

As a result of market difficulties, many Americans are surprised by low balances in their investment accounts. However, these low balances also present an opportunity in the form of Roth conversions. As mentioned above, Roth conversions are taxed based on the value of the account rolled over. At a time when account values ​​are low, the price of becoming a Roth is also relatively low. Assuming the market is down 20%, a Roth conversion can also be completed for 20% less. And those who believe the market will eventually recover can take advantage of that tax-free recovery.

For many Americans, a Roth conversion represents an opportunity to diversify retirement savings while benefiting from tax-free growth. However, you should always consult with your tax advisor before doing a Roth conversion, as they can best assess your personal circumstances. Additionally, Roth conversions require tax to be paid in the year of conversion, so prospective converters should make sure they have cash on hand to cover that tax liability. With the right plan, a Roth conversion could protect your retirement plan from higher future tax rates and save you some tax liability down the road.

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