Should You Consider a Roth Conversion While the Market is Down?

Retirement Planning

A market downturn can seem crippling. Managing your expenses and aiming for financial growth can be challenging as your investments start to fall and inflation rises. The stock market has been a cause of concern of late. Several global crises have led to an economic backlash. Starting from the pandemic that surfaced in 2020 to the Russia-Ukraine war in 2022, there have been massive disruptions in the recent past. However, as short-term eventualities present themselves, it is essential to keep an eye on the prize and plan long-term. Long-term investments can help you override short-term market volatility and achieve your future financial goals. The 401(k) and IRA have been two widely used long-term financial tools in the U.S. The latter may have something to offer you at present when the market is down.

The Individual Retirement Account (IRA), as the name suggests, is a retirement account. There are two types of IRAs – traditional and Roth. A Roth conversion is a popular option that many investors opt for. There can be several pros and cons to this. However, a Roth conversion may be specifically good in the case of a market downturn. If you are wondering if now is a good time to do a Roth conversionthe answer is yes. If you want to learn about Roth conversions, their pros and cons, and whether such a step would be beneficial for you or not, reach out to a professional financial advisor who can guide you on the same. But before you go ahead and convert your traditional IRA to a Roth one, you must know a few things.

Find out everything you need to know about a Roth conversion and when should you convert to a Roth IRA.

What is a Roth conversion?

As stated above, there are two types of IRAs. The traditional IRA lets you contribute your pre-tax dollars. This way, your money grows tax-deferred, but your withdrawals in retirement after the age of 59.5 are taxed as per ordinary income. The Roth IRA works in the opposite manner. It lets you contribute your after-tax dollars, so your money grows tax-free, and your withdrawals are not taxed when you redeem your money after the age of 59.5. A traditional IRA is suitable if you expect to be in a lower tax bracket post-retirement, as you get immediate tax relief and save money in the present. On the other hand, a Roth IRA is ideal if you think you will be in a higher tax bracket in the future. This way, you can pay tax now and enjoy tax-free money later. Another difference between the two is that a Roth IRA does not have mandatory distributions in retirement. However, traditional IRAs have Required Minimum Distributions (RMDs) after the age of 72.

The annual contribution limit for an IRA in 2022 is capped at $6,000. People aged 50 or above can contribute another $1,000, bringing the total to $7,000. The limit is applicable for both accounts. This means that you can contribute a total of $6,000 or $7,000 if you have both a Roth IRA and a traditional IRA.

A Roth conversion is when you transfer the money in your traditional IRA to a Roth IRA. This can have many benefits. However, it is vital to know when should you convert to a Roth IRA to benefit from it.

If the market crashes, what happens to my IRA?

Your IRA is made up of different investments. A Roth IRA can have multiple investments like stocks, mutual funds, exchange-traded funds (ETFs), bonds, certificates of deposit (CDs), and money market funds. These investments help you build wealth for the future. However, since all of these investment options are linked to the market, your IRA value is affected when the market crashes.

When the market falls, stock prices drop, mutual fund returns plummet, and the ETFs can deliver low returns. While some bond options can balance the losses, your overall returns may still be lower than what you expect. The IRA value can drop significantly depending on different market forces. However, since an IRA is a long-term investment vehicle, you can cover up for the losses in time when the market recovers.

Should I convert my IRA to a Roth IRA?

Converting to a Roth IRA is considered chiefly to get a tax break. You can convert to a Roth IRA if you want to save tax in the future. Most people feel that their tax output is higher in the present when they are earning an income. Retirement income comes from investment returns and savings. These are a limited pool of money, so the evident conclusion is that the income in the future should not be taxed as taxes can further lower your corpus and create a shortage. By paying tax now, you can save money later when you have no active source of money and protect your limited savings pool. However, here are a few things to know before you take the step:

1. Consider a Roth conversion only if you have enough money to pay taxes right now:

When you convert your traditional account to a Roth account, you owe tax on the money right now. So, the money that was growing tax-deferred till now will be taxed according to your current annual income. If you fall in a high tax bracket, your income tax may already be high. Adding the money from a traditional IRA can further increase your tax output. If you do not have enough funds, you may find it challenging. A market downturn often affects employment. Many economists are predicting a recession in the near future. A recession can lead to unemployment, inflation, and salary cuts. If you lose your job or your salary is reduced, you may need money to counter inflation and get by without an active income. Converting at this time can be tricky, with no immediate source of cash to cover the taxes.

2. Convert to a Roth IRA if your income is lower in the year of conversion:

A salary cut may make it challenging to pay the upfront tax on the conversion. However, there can be an upside to it. The IRA money is added to your ordinary income and taxed accordingly. If you fall in a lower tax bracket, adding on the IRA money will still not be such a significant liability. If your business has suffered from a loss or your income is relatively lower than expected, you can consider a Roth conversion and curtail the tax hit.

3. Convert only if your tax rate in the future would be higher:

The deciding factor between a Roth and a traditional IRA is tax. If you expect to pay a lower tax rate in retirement, sticking to a traditional IRA may be more suitable. The only thing to focus on when converting your account is to find a way to save money on your taxes. If you end up being in a higher tax bracket now than you would in the future, the conversion will not benefit you in any way. So, if you are considering a conversion, it may be advised to get in touch with a financial advisor and analyze your investment choices and their likelihood of returns. If your savings and investments help you build a considerable corpus in retirement, this money will not be taxed in the future if it is lying in a Roth IRA. This way, you can get rid of all taxes now and enjoy a higher monthly income after retirement.

4. Opt for a Roth conversion if you wish to leave a tax-free inheritance for your beneficiaries:

One of the biggest advantages of a Roth IRA is that you do not have to take RMDs. A traditional IRA and 401(k) have mandatory RMDs starting from the age of 72. So, irrespective of whether you need the money or not, you must withdraw it. If not, you would have to pay the penalty. When you draw this money, your withdrawals will be taxed, so the state can earn money. This would not be ideal if you wish to leave a legacy behind you for your spouse, kids, or grandkids. A Roth IRA, on the other hand, does not have obligatory RMDs. So, you can let the money be if you do not need it and have enough savings to cover your retirement expenses. This money can then be passed on to your family after your demise, and they can enjoy tax-free money for their financial needs. However, this can only occur if your IRA has been open and active for at least five years, as withdrawals before five years from opening the account are levied a 10% penalty.

5. Consider a Roth conversion if you are not retiring immediately:

If you are retiring in less than five years and will be relying on your IRA income in retirement, a Roth conversion may not be ideal. All IRAs have a five-year rule, according to which you have to wait for at least five years after the account is opened to withdraw your money. Even if you have had a traditional IRA all your life, the five-year rule will be implemented on the Roth conversion. A conversion is treated as a new account. So, if you convert your traditional IRA in 2022, you would only be able to withdraw from it in 2027 as long as you are at least 59.5 years old at the time of withdrawal. If you retire before 2027, you would not be able to use the money from the Roth IRA without paying a 10% penalty.

Other than these factors, converting to a Roth IRA can be highly beneficial when the market is down. More of this is explained below.

Is now a good time to do a Roth conversion?

The market is down, which makes it an excellent time to consider a Roth IRA conversion. When you convert your traditional IRA to a Roth IRA, you have to pay tax upfront on all your pre-tax contributions as well as the earnings in the traditional IRA. This can be a high amount depending on how long you have been investing and the type of investments you have in your traditional IRA. However, your IRA investments drop when the market falls. For example, if you had $120,000 in your traditional account when the market was up, you would be paying tax on the entire $120,000. But if your investments fall to $90,000 because of the market downturn, you would pay tax on the $90,000 and not $120,000. The lower the value of your investments, the lower the tax imposed on them. This allows you to convert your account by paying a smaller tax payment than if the market was high and your investments were performing well.

When the market recovers eventually, your investments will also likely catch up, and you can be on track to achieving your financial goals. However, you would have paid off a significant tax liability and can now look forward to tax-exempt withdrawals. In addition to this, you would also not be burdened by RMDs in retirement.

Having said this, it is essential to note that a Roth conversion can increase the current year’s modified adjusted gross income (MAGI). MAGI can dictate the monthly premiums for Medicare Part B. The premiums are calculated on the basis of the last two year’s MAGI. So a conversion now may result in a higher premium in 2024.

Should I convert my 403b to a Roth IRA?

A 403b plan is a retirement account designed for employees of public schools and tax-exempt organizations only. As of 2022, you can contribute up to $20,500 in a year. The catch-up contribution for those aged 50 or more is capped at $6,500. 403b plans invest in money market accounts, mutual funds, and annuities.

You can also convert a 403b plan to a Roth IRA besides your traditional IRA. You can transfer the 403b funds to a Roth IRA or withdraw money from a 403b and deposit it in your new Roth IRA within 60 days. However, both methods will trigger tax consequences. You will owe tax on the money and would have to make a decision based on the same factors as in the case of a traditional IRA.

To conclude

A Roth conversion can be good for tax diversification as most other investment returns and savings are taxed in retirement. So, a Roth IRA can be an exception here and help you save money. With the market experiencing a downturn, your immediate tax hit would be lowered, and you can get away with a conversion with minimal collateral damage. However, there are several aspects to consider in a Roth conversion, and you must opt for it only if you think it is the ideal deal for you.

A financial advisor can help you make this decision by offering better clarity on the pros, cons, and precise consequences for you. Use the free advisor match service to connect with 1-3 financial advisors based on your financial requirements. All you need to do is answer a few simple questions about yourself and the match tool will find advisors that match your financial needs.

To learn more on the most suitable retirement savings strategies for your unique financial requirements, visit Dash Investments or email me directly at