Is Right Now a BAD TIME for Roth Conversions?
As we navigate the intricacies of personal finance, one question that often arises is whether now is the right time to consider a Roth conversion. A Roth conversion involves transferring funds from a traditional IRA or 401(k) into a Roth IRA, which can offer tax-free growth and tax-free withdrawals in retirement. While the potential benefits are appealing, the decision to proceed with a conversion can be influenced by several factors, making it crucial to evaluate the current economic climate and personal circumstances.
Understanding Roth Conversions
Before delving into whether now is a bad time for a Roth conversion, let us briefly summarize how this financial maneuver works. When you convert retirement funds from a traditional account to a Roth IRA, you pay taxes on the converted amount at your current income tax rate. After the conversion, the funds grow tax-free, and qualified withdrawals in retirement are also tax-free.
This strategy can be advantageous for those who anticipate being in a higher tax bracket in retirement or want to minimize their tax liability for their heirs. However, timing plays a critical role, and several indicators can determine whether this is an optimal moment for a conversion.
Current Economic Climate
1. Tax Rates and Legislation
One of the primary considerations when evaluating a Roth conversion is the current and projected tax rates. As tax laws and rates can change, individuals must consider whether they believe their tax rates are relatively low or expected to rise in the future. Given recent discussions around tax reforms and deficits, many taxpayers are concerned about future tax increases. If you believe that tax rates will rise over the long term, converting to a Roth IRA now may be wise.
2. Market Conditions
The state of the financial markets can impact the decision to convert. If the market is down, converting investments that have lost value may provide an opportunity to pay taxes on a lower amount. For instance, if you have a traditional IRA worth $100,000 that has dropped to $80,000, a conversion could mean paying taxes on the $80,000 rather than the original value. Conversely, if the markets are strong and your investments are performing well, you may want to hold off to avoid paying taxes on a larger amount.
3. Personal Income Changes
An individual’s current income situation is another critical factor. If you are experiencing a temporary dip in income due to a job change, sabbatical, or other reasons, this may be a good time to consider a Roth conversion. Lower income may push you into a lower tax bracket, allowing you to convert and pay taxes at a more favorable rate. Conversely, anyone with a high income or significant bonuses may find that converting now could push them into a higher tax bracket, resulting in a larger tax burden.
Other Considerations
1. Long-term Financial Goals
Your overall retirement strategy should guide your decision to convert. If your financial goals align with the benefits offered by a Roth IRA—such as the desire for tax-free income in retirement or estate planning objectives—then it may still be a good time to convert, regardless of current economic conditions.
2. Age and Time Horizon
Younger individuals with a long time horizon before retirement can often benefit from Roth conversions, as they have more time for investments to grow tax-free. Conversely, older individuals may need to assess whether the immediate tax burden of converting outweighs the benefits of tax-free withdrawals later.
Conclusion
Ultimately, whether now is a bad time for a Roth conversion depends on a combination of factors, including current market conditions, tax implications, personal income levels, and individual financial objectives. Those who are considering a Roth conversion should carefully evaluate their unique circumstances and perhaps consult a financial advisor or tax professional.
The decision to convert is significant and should not be taken lightly. As with any financial strategy, the key is to stay informed, be proactive, and align your decisions with your long-term financial goals.
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I've tried to time my Roth conversion chunks to market downdrafts as recommended here by SWM, always paying the conversion tax out of my taxable acc't. But, I have a lingering question that is skimmed over in this otherwise authoritative analysis. In the two comparison cases presented above, the tax cost for the $100K conversion is given as the same $18K. But, in the downdraft case, wouldn't whatever asset is liquidated then to pay the $18K tax have suffered the same hypothetical 20% market downdraft as well? And, assuming this, is the case still preferential? Or, does it become a wash? (Due to SWM's "commutation of multiplication" tongue-in-cheek observation in another of his videos.)
My question is do I have to liquidate my equities to do a conversion? Can the stocks be transferred into a Roth ? If they can it would probably be smart to do it before a dividend pay out or on a dip in value of that particular stock.
Why is the tax amount listed at $18K in the video? A $100K conversion for us in California at this point would be about 45% including state tax. So $45k!
We do ROTH conversions filling our tax bracket so if in the future we need to make a major purchase we have money to pull from without bumping up our tax bracket. If we end up not spending it great, but unlike most it is not penciled in as "long term"
Thanks Eric. Excellent analysis & explanation. Waiting for the "perfect" is a fallacy in life. Better is the enemy of good enough.
I'm 61 and still working. I'm trying to make a decision whether I should start doing conversions now when my income is high or wait until I retire and put off SS and other pensions, making my income much smaller for a few years so I will pay less taxes.
I think your content is marvelous. Straight forward and logical.
@safeguardwealthmanagement – I understand that once you open a Roth IRA, once your first Roth IRA is over 5 years old, you can use that money and money in any other Roth IRA without any penalties (provided you are over 59.5 years old). But, is it true that when you do a Roth conversion, do you have to wait 5 years to cash that money? Do you have to start over and wait another 5 years after every Roth conversion (say you convert 100k in 2022, you wait 5 years and you convert another 100k in 2023, do you have to wait another 5 years for that conversion)?
How do we balance conversion at 32% married rate now in down market vs a lower bracket conversion later in early retirement?
I do my Roth conversions at the beginning of the year on the assumption I get an extra years gains and I can't time the market. Sometimes I win sometimes I loose. This year I lost, but the money won't be needed for another 15 or more years. Can't look back.
Anything about Roth conversions on your channel always catches my interest! Excellent. Fyi waiting for your future book! Steve n.y.
Is it necessary to complete RMD withdrawals before making ROTH conversions?
Thank you very informative
i thought you could only do 1 conversion a year? am i missing something here?
Is it true that when you convert money via a Roth conversion that while considered income from a tax bracket perspective, it does not affect your AGI relative to Roth contributions?