Many investors have watched their long-term retirement savings fall more than 13% year to date. For perspective, if your IRA was $500,000, you may have lost nearly $65,000 since the start of the year. That hurts when you put some real numbers behind it.
With inflation increasing your everyday costs and waning consumer sentiment, it can be hard to find opportunities in the current economy. However, depressed account balances may provide an opportunity for investors to convert traditional retirement accounts to Roth IRAs. The more equity losses are, the more attractive a conversion can become.
Roth IRAs have many advantages, including tax-free growth of money, no required minimum distributions, and the ability to tap principal after five years. Converting traditional IRA funds to a Roth IRA can help you lower your required minimum distributions and use it as an estate planning tool to provide a tax-free inheritance for your heirs. Roth IRAs also allow investors to have a bucket of tax-free funds in retirement.
Unfortunately, Roth IRA contributions are only available to those with modified gross income less than $144,000 for the tax year 2022 for single filers and under $214,000 for those married filing jointly. However, all investors are allowed to convert a traditional IRA to a Roth IRA regardless of income.
Let’s say your $500,000 IRA is now down to $435,000. Ordinary income tax is due on the amount converted to a Roth, so you will pay less tax by converting a lower amount. If you are married filing jointly and in the 24% tax bracket, that could save you $15,600 in taxes ($500,000 x 24% = $120,000 while $435,000 x 24% = $104,400). We highly recommend being able to pay the tax due from another account like a brokerage or savings account. Paying the tax due from the converted funds would at best reduce the value of the assets receiving the tax-free growth, or at worst may constitute an early withdrawal penalty and could negate any benefit.
A Roth conversion isn’t all or nothing either. Working with your financial and tax advisers, you can determine how much to convert, keeping you from moving into a higher tax bracket for the year. You could also choose to convert only a portion now and wait to see where the market continues to move. Should the market continue to fall, you may convert more later in the year. Furthermore, you don’t have to liquidate your account to make a conversion—your investments can stay intact, so there is no risk of being out of the market. You can also pick specific funds to move from the IRA to the Roth, choosing to move shares having the deepest losses for the year—especially if they’re high-quality stocks that you expect will recover.
If you have a 401(k) at a previous employer, you can move your balance to an IRA Rollover account and then convert the money to a Roth IRA. Additionally, some 401(k) plans allow for in-plan conversions that may allow you to convert tax-deferred 401(k) funds to a Roth 401(k), gaining you similar tax-free growth. However, while there may not be early-withdrawal penalties, this is still considered a taxable event.
If you have questions on how to begin shifting your asset allocation for retirement, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the June 4, 2022 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
