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  • Writer's pictureSteve Coker, CFP

Roth Conversions

With the stock market down in 2022, now may be a great time to consider converting a portion of your traditional IRA to a Roth IRA. We have written about Roth conversions before, but as a reminder, a Roth conversion is when you move assets from a traditional Individual Retirement Account (IRA) to a Roth IRA. You must pay income taxes on the value of the assets converted, but the Roth IRA grows tax free from that point forward. The Roth IRA also avoids Required Minimum Distributions for the owner and can benefit heirs by continuing to grow tax free when inherited. The bottom line is that the tax savings of a Roth conversion can be significant.

Since the market has declined during 2022, converting now will allow you move assets to a Roth at a lower tax cost, and when the economy recovers the Roth IRA and any future growth within the Roth IRA will be tax free. For example, if you had a $10,000 IRA at the end of 2021 and you took a 25% hit during the market downturn, you would now have $7,500. If you convert it to a Roth now it will generate only $7,500 in taxable income – a 25% discount compared to the beginning of the year. If the account recovers back to the $10,000 you will have converted your traditional IRA at a 25% discount. Now you have $10,000 once again, but it is in a tax-free account which will continue to grow income tax free.

We continue to emphasize Roth conversions since the future of the strategy is in doubt. Several proposed tax bills have eliminated Roth conversions. For 2022 Roth Conversions are still allowed but future tax law changes could close the door. We also have historically low income-tax rates. Given the pace of government spending it is likely that future income tax rates will be higher.

There are several factors to consider when deciding how much to convert:

  • Consider the tax bracket you are presently in. For example, if you are in the 24% bracket, you would ideally not want to convert so much that it bumps you up to the next bracket at 32%. It is often a good strategy to convert a small amount of your IRA each year, filling up your current tax bracket during retirement.

  • Consider you time horizon of when you need to use your IRA funds. For example, you would ideally want to have a longer-term time horizon to let it grow tax free and offset the current year hit for the taxes you pay on conversion. If you for example, convert $10,000 this year but need to withdraw it in only two years, it’s not going to make sense to take the tax hit now versus two years from now. (Note that for first time Roth conversions and contributions, you need to wait five years before withdrawing the funds).

  • Consider how you will pay the taxes on the conversion amount. Do you have the cash or assets to pay the taxes?

We will be preparing Roth conversion analyses for our clients during the months of September and October and will be reaching out if you are a viable candidate for the strategy. If you are interested in discussing your situation, please feel free to give us a call.


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