Why now may be the perfect time to convert your IRA to Roth

Why now may be the perfect time to convert your IRA to Roth

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


Key points

  • Unlock tax-free growth using a Roth conversion.
  • The market is at a discount, and so is the price of a Roth conversion.
  • Always consult a tax professional before making a conversion.

A well-diversified retirement plan requires more than just a variety of investments. Investors should also consider how savings will be taxed when withdrawn at retirement. Most Americans save for retirement on a before-tax basis, but retirement income should also include some after-tax, or Roth, savings. Fortunately, Roth conversions are available to many people with IRAs, potentially reducing their 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 take action.

What is a Roth conversion?

Basically, a Roth conversion allows you to exchange a pre-tax IRA for a Roth IRA, even if your income exceeds the Roth IRA income limits. By converting a traditional account to a Roth account, income taxes can be prepaid today for tax-free income in retirement. This strategy works in two stages because 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 consider the $50,000 as gross income, which could be fully or partially taxable at your marginal tax rate. At retirement, the Roth IRA balance, including the $50,000 and any gainwould not be taxable or subject to RMD.

Why do a Roth conversion? It depends on future taxes. If you expect to be in a higher tax bracket in retirement than you are now, paying taxes early through a Roth conversion can be attractive. You may find yourself in a higher tax bracket for a number of reasons, including recognition of large income 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 past 90 years. In addition, the prepayment 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 IRA accounts of 2022.

What’s happening in the market?

It’s no secret that the market is not doing very well right now. Since the start of the year, stock prices have fallen dramatically across a wide range of industries. Bond prices, traditionally viewed as a foil to stock market movements, also performed poorly in response to a high interest rate environment. In short, the market is doing poorly whether you’re an equity investor, a debt holder, or have a bit of both in a diversified portfolio.

Is it the right time for a Roth conversion?

Due to market difficulties, many Americans are shocked by the 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 taxable based on the value of the transferred account. At a time when account values ​​are low, the price of converting to Roth is also relatively low. Assuming the market is down 20%, a Roth conversion can also be achieved for 20% less. And those who believe the market will eventually recover can take advantage of this tax-free recovery.

For many Americans, a Roth conversion represents an opportunity to diversify retirement savings while enjoying tax-free growth. However, you should always consult your tax advisor before proceeding with a Roth conversion, as they are in the best position to assess your personal situation. Additionally, Roth conversions require the payment of taxes in the year of conversion, so potential converters should ensure they have cash on hand to cover this 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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