Why Now May Be a Great Time to Convert Your IRA to a Roth

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

A well-diversified retirement plan needs more than just a variety of investments. Investors should also consider how savings will be taxed upon withdrawal in retirement. Most Americans are saving for retirement on a pre-tax basis, but retirement income should also include some post-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 find out more about what Roth conversions are and why now is one of the best times to act.

What is a Roth conversion?

At its core, a Roth conversion allows you to swap 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, income taxes can be prepaid today for tax-free income in retirement. This strategy works two-fold, as Roth IRAs are not subject to Required Minimum Distributions (RMDs).

Here is a simple example: Imagine you want to convert $50,000 of pre-tax contributions from your traditional IRA to a Roth IRA. You would recognize the $50,000 as gross income, which may be fully or partially taxable at your marginal tax rate. In retirement, the balance of the Roth IRA, including the $50,000 and any gains, would not be taxable, nor subject to RMDs.

Why do a Roth conversion? It comes down to future taxes. If you expect to be in a higher tax bracket in retirement than you are currently, prepaying taxes through a Roth conversion may be appealing. You might be in a higher tax bracket for a number of reasons, including recognizing significant income due to high rates of saving, or tax brackets being increased by Congress. Tax rates are constantly changing, and current rates are relatively low compared to the last 90 years. Additionally, prepaying taxes on an investment account in exchange for tax-free growth is a very appealing feature of a Roth IRA.

Ready to open a Roth IRA? Check out our best Roth IRA accounts of 2022.

What’s going on in the market?

It’s no secret that the market isn’t doing great right now. Since the beginning of the year, stock prices have fallen dramatically across a wide range of industries. Bond prices, traditionally believed to be a foil for stock movement, have also been performing poorly in response to a high interest rate environment. Long story short, the market is doing poorly, regardless of whether you are an equity investor, debt holder, or have a little bit of both in a diversified portfolio.

Is now the right time for a Roth conversion?

As a result of the struggling market, 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 account rolled over. At a time when account values are low, the price of converting to a Roth is also relatively low. Assuming the market is down 20%, a Roth conversion can be completed for 20% less as well. And those who believe that the market will eventually recover can take advantage of that recovery on a tax-free basis.

For many Americans, a Roth conversion represents an opportunity to diversify retirement savings while benefiting from tax-free growth. However, you should always consult with your tax advisor before doing a Roth conversion, as they can best assess your personal circumstances. Additionally, Roth conversions require tax payment in the year of the conversion, so prospective converters should ensure that they have cash on hand to cover that tax liability. With the right plan, a Roth conversion could protect your retirement plan from higher future tax rates, and save you from some tax liability along the way.