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June 21, 2022

Is the Time Right for a Roth Conversion?

A downturn in the stock market may cause the value of your retirement account to decrease. However, if you have a traditional IRA, this decline may provide a valuable opportunity: It may allow you to convert your traditional IRA to a Roth IRA at a lower tax cost.

Roth vs. traditional IRAs

Roth IRAs differ from traditional IRAs in a few key ways: 

Roth IRA

Contributions to Roth IRAs are never deductible. However, withdrawals and their earnings are nontaxable if you're over 59 ½ years of age and your account is at least five years old. Additionally, contribution withdrawals are always allowable and are tax and penalty-free. RMDs are also not mandatory until you reach age 72.

There are, however, contribution limitations to a Roth IRA based on your modified adjusted gross income (MAGI). You can always convert your traditional option to a ROTH so long as you pay any income tax owed. 

Traditional IRA

Traditional IRA contributions may be deductible based on your MAGI and if you or a spouse participate in a qualified retirement plan, like a 401(k). The funds in this account can grow tax-deferred. 

One disadvantage to this is that withdrawals are usually taxed as income. If you make any withdrawals before the age of 59 ½, there are also penalties that may be imposed, unless you qualify for certain exceptions. You still have a required minimum distribution requirement starting after age 72.

Reducing your tax bill

When the stock market takes a downturn, you may see a benefit. For example, suppose your traditional IRA loses some of its value. You could save on your taxes by converting to a Roth sooner than later. You'll also sidestep appreciative taxes when the market rebounds. 

Before you decide to convert, take the following considerations into account: 

Do you have enough funds to cover the tax bill? Those without much cash on hand for conversion taxation costs may need to withdraw this expense from their retirement savings, which is detrimental to your goals. Remember, tax brackets increase according to how much money you convert, which means a hefty tax obligation later. 

What retirement plans do you have? Whether you should convert or not might hinge on what stage in life you’re at. If you’re close to retiring, going from a traditional to Roth IRA option doesn't make sense since you'll draw on those accounts immediately. Typically, you choose a conversion if you still have time for funding growth and to let them compound over time.

Converting from a traditional IRA to a Roth doesn't require you to commit all your money at once. This is a flexible process where you can use whatever percentage you wish, allowing you to slowly change over and take years to absorb the tax hit instead. 

Keep in mind that before going through with a Roth IRA conversion, there are additional steps and considerations to account for. If you think converting to a Roth is ideal for your financial goals, reach out today to learn more.  

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