Key Points
A Roth conversion helps you reduce your future tax liability and RMDs.
Converting during a market downturn could be advantageous.
Make sure a Roth conversion is actually right for you.
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If you like the idea of not paying taxes on retirement plan withdrawals and avoiding required minimum distributions (RMDs), a Roth conversion could make a lot of sense. With a Roth conversion, you transfer funds from a traditional IRA or 401(k) into a Roth IRA.
When you do a Roth conversion, you pay taxes on the amount you move over each year. But from that point onward, your money gets to grow tax-free.
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You'll often hear that the optimal time to rebalance an investment portfolio is when the market is up. So you might assume that the same holds true for doing a Roth conversion.
But actually, a down market could be a fantastic time to do a Roth conversion. Here's why.
Lower taxes are a big win
One big advantage of doing a Roth conversion during a market downturn is the ability to convert more assets into a Roth account while generating a smaller tax bill.
Let's say your IRA balance falls from $500,000 to $450,000 during a market slump. Converting a portion of that after the drop means paying taxes on the lower current value of your assets -- not their value before that market drop. Then, if you have those assets in a Roth IRA, once the market recovers, they'll get to grow tax-free.
Is a Roth conversion right for you?
Doing a Roth conversion when the market is down could benefit you. But you shouldn't rush into one because the market is down. Rather, you should do one because you feel it's the right strategy for you.
A Roth conversion may be beneficial to you if:
- You don't like the idea of having to take RMDs and want more freedom with your savings.
- You're hoping to use your retirement nest egg as a wealth transfer tool and pass a portion of your savings along to heirs.
- You think you'll be in a higher tax bracket in retirement than you're in now.
- You can afford to pay taxes for the conversion or have a taxable account you can pay those taxes out of.
You might assume that you shouldn't touch your IRA or 401(k) when the market is down. But while selling off assets at a loss during a market decline is generally not a good idea, a Roth conversion is a different story. You may find that a market slump is a great time to complete a conversion in a more tax-efficient manner.
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