Stocks are down, but it's a 'great time' for a Roth IRA conversion—here's why (2024)

Unless you hold some niche investments, the value of your portfolio is likely down at the moment. The S&P 500 has surrendered about 18% over the past 12 months, and the broad bond market hasn't done much better, having lost 13%.

But depending on your tax situation and which kinds of accounts you hold, now may be an excellent time to move money from a traditional IRA into a Roth account, a move known as a Roth conversion.

Because Roths are funded with money you pay taxes on upfront, you'll owe a bill on any investments you move over. But the less those investments are worth, the less you pay in taxes.

"Because the market is down, now is a great time to be talking about Roth conversions," says Brian Schultz, a certified public accountant and tax partner at accounting and wealth management firm Plante Moran. "Converting at a lower cost than normal has been huge for some investors who have been able to benefit."

Here's why financial pros say a Roth conversion could be a worthwhile move right now for anyone who might be considering it.

To understand the benefits of a Roth conversion, it's important to know the key differences between traditional and Roth IRAs.

Traditional IRAs are funded with pre-tax money, which means you can deduct any contributions you make in a given year from your taxable income. But because you're foregoing taxes up front, you'll owe them when you withdraw the money in retirement. You'll also owe a 10% penalty if you withdraw the money before age 59½.

Roths, on the other hand, come with no upfront deduction since you fund these accounts with money you've already paid taxes on. But once you turn 59½, provided you've held the account for five years or more, you can withdraw all of your money, including investment gains, tax-free. And you're allowed to withdraw up to the amount you've contributed at any time without penalty.

Which account makes sense for you depends on your individual financial situation, but generally, a Roth is recommended if you expect to pay lower taxes now than when you retire. That's why many financial pros recommend Roth IRAs for early-career investors whose salaries are likely to increase and push them into higher tax brackets.

Keep in mind that the government can raise taxes as well. But because all income you earn from a Roth in retirement is tax-free, these accounts can provide peace of mind to investors of any age, says Ed Slott, a certified public accountant and founder of IRAHelp.com.

"Your money just grows for you income tax-free for rest of your life, which makes converting a good hedge for higher tax rates in retirement," he says. "You can't beat a 0% tax rate."

While the reasons above can make a Roth conversion attractive for anyone who fears their tax rate may be higher in retirement, it can be especially useful for young workers who expect to earn more income toward the end of their careers and near-retirees who fear they'll owe higher taxes on their IRA distributions should the government increase tax rates.

If that sounds like you, here's why now may be the time to do it.

Because you haven't been taxed on any of the money in your traditional IRA, you'll owe taxes if you convert to a Roth. But if the value of your portfolio is down right now, it's cheaper than usual to move your shares over.

Say you own 10 shares of an ETF, each worth $100, in your traditional IRA. If you convert it to a Roth, you'd owe taxes on the dollar value of the shares: $1,000. But if your portfolio declined by 20%, you could move those same 10 shares over and pay taxes on $800.

Once your stocks are converted, they'll ideally continue to grow tax-free in your Roth account until you're ready to withdraw the money in retirement.

"There's no question if you're paying for something and it costs less, that's good," says Slott. "But you don't really know when the market is really down. It's hard to time the market for a Roth conversion."

As Slott points out, the market could rebound or drop further from current levels, so you'll never know if you're getting the best possible deal.

That's why, if you're interested in converting, he suggests scheduling a series of small conversions between now and 2026, when the lower tax rates set forth in the Tax Cuts and Jobs Act are set to expire.

"You could do it this year, then again in 2024 and 2025, and then the party, according to the current law, is over," Slott says. There is no limit to how much you can convert in a single year nor how many conversions you can do.

Like nearly anything involving taxes and investments, Roth conversions are complicated moves that are best made under the supervision of a trusted professional.

There are also a few drawbacks to be aware of when deciding if this is a smart move for you.

First, they're permanent. You are no longer allowed to "recharacterize" your Roth conversion back to a traditional IRA. If you convert some of your investments, the tax bill is coming due, even if a financial emergency depletes your cash reserve between the time of the conversion and Tax Day.

Depending on how much money you move over, performing a conversion could mean a large influx of income — potentially enough to push you into a higher bracket. That could, in turn, disqualify you from certain tax breaks.

And don't convert any money that you'll need soon. You can't withdraw your converted Roth funds, or their earnings, for five years after making the switch, regardless of your age. If you do, you'll owe taxes on the amount withdrawn plus a 10% penalty.

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