Roth Conversions in a Down Market

Most financial planning conversations happen when things feel good. Income is strong, markets are cooperating, and thinking about the future seems straightforward.

Some of the more useful planning moves, though, tend to present themselves when conditions are less comfortable.

A Roth conversion is a good example. The basic idea is that you move money from a traditional IRA or 401(k), where contributions were made before tax, into a Roth account, where future growth and withdrawals will be tax free. You pay ordinary income tax on whatever amount you convert in the year you do it.

When markets are down, that math becomes more favorable. If your traditional IRA has declined in value, you are converting a smaller dollar amount and paying tax on less. When the market recovers, that recovery happens inside the Roth where it compounds without future tax consequences. You have essentially moved assets at a lower cost and positioned the rebound to work in your favor.

Some context before deciding

Because a conversion adds to your taxable income for the year, timing matters. The goal is usually to convert enough to take advantage of the opportunity without pushing into a higher bracket than makes sense. For some families there is a natural window between retirement and when Social Security begins where income is lower, and conversions are especially attractive.

There are also estate planning considerations worth mentioning. Heirs who inherit a Roth account generally do not owe income tax on what they receive. For families who are thinking about what they eventually pass on, that can be a meaningful difference.

A conversion is not the right move in every situation. If you expect your tax rate in retirement to be significantly lower than it is today, or if you will need access to the funds in the near term, it may not pencil out. But for families with longer time horizons and room to absorb additional income in a given year, periods of market weakness have historically been good times to act.

If you want to think through whether a conversion makes sense for your situation, we are glad to work through the numbers with you. Schedule a time here.