Why Now Might Be the Right Time for a Roth IRA Conversion | Barnes Dennig

Why Now Might Be the Right Time for a Roth IRA Conversion

Published on by Andy Bertke in Tax Services

Why Now Might Be the Right Time for a Roth IRA Conversion

Current market conditions may be wreaking havoc on your retirement account – but while no one likes to see the numbers drop, there may be a silver lining: if you’ve ever considered converting to a Roth IRA, now may be the perfect time.

Here’s why: a significant drop in your retirement plan savings or IRA may mean that you can convert to a Roth IRA with a lower tax cost than when the markets are up. When you convert to a Roth IRA, the conversion is treated as if a traditional IRA were distributed to the account owner – so there’s tax owed on the traditional IRA’s value. When the value is lower, so is the tax burden. (It’s worth noting that the tax burden doesn’t apply to any after-tax IRA contributions – and that the 10% early distribution penalty doesn’t apply, either, but it’s still a significant tax hit).

If your current year losses are high enough to offset the cost of the conversion, 2022 may be your sweet spot for making the switch.

Why consider a Roth IRA

Unlike traditional IRA distributions, Roth IRA distributions are tax-free as long as specific conditions are met – that’s because Roth IRA contributions aren’t tax-deductible, so the IRS is getting its share upfront. What makes a Roth IRA so attractive, though, is that the earnings on the account are potentially not subject to tax.

Another reason to consider the conversion: Roth IRAs also aren’t subject to required minimum distributions (RMD) during the account owner’s lifetime, so the account earnings can continue to grow tax-free. RMDs for other types of IRAs, including SIMPLE, SEPs, and 401(k) plans kick in when the account owner turns 72. Not having to take RMDs can also reduce your adjusted gross income (AGI), so your tax burden overall is likely to be lower.

Finally, Roth IRA owners can withdraw funds from the account at any time after an initial 5-year period, without being taxed or subject to the 10% early distribution penalty – so the taxpayer has much greater flexibility with these funds than with a traditional IRA. (Funds withdrawn prior to the 5-year mark are subject to the penalty.)

What makes a good Roth IRA conversion candidate

If you meet one or more of these criteria, it may be worth talking with a wealth management advisor about whether a Roth IRA conversion is a good fit.

  • Current year losses that offset the conversion cost
  • Traditional IRA or employer retirement plan with little to no gain
  • At least 15 years after conversion before distributions are expected
  • Higher federal and state tax rates expected at the withdrawal point
  • Expiring pre-2018 net operating losses (NOLs)
  • Ability to pay tax on conversion without dipping into the IRA

Some watch outs

For a Roth IRA conversion to make sense, you’ll need to be able to keep the funds earning a return long enough to offset the tax impact of the conversion and be prepared to leave the funds in the account for a minimum of five years so you don’t get hit with the 10% early withdrawal penalty.

Talk to a tax planning pro

There are a lot of factors that go into determining whether a Roth IRA is right for your situation – or if there’s another approach that would provide a greater benefit. If you’d like to explore the possibilities, connect with one of our top tax planning pros for a free consultation. As always, we’re here to help.



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