Time for A Roth Conversion?

Stock and bonds are falling as investors react to rising interest rates and inflation, and most balanced portfolios are down significantly. Vanguard’s Balanced Index Fund is 60% stocks and 40% bonds and has fallen 14%. Is there a silver lining to lower account values? I think so, especially if you convert your traditional IRA to a Roth.

As markets drop, now can be an ideal time to convert your traditional IRA to a Roth. Since your account value is lower, you will pay less tax on your conversion, and your future gains will be tax-free when stocks rebound.

Here is an example. Let’s say your current IRA value is $1 million, and you decide to convert 20% of your account over the next five years. When you transfer $200,000 (20% of $1 million) to your Roth, you will pay ordinary income tax on the distribution. After five years, you moved your entire IRA balance to a Roth, so you will no longer pay taxes on distributions. It’s 100% tax-free!

Let’s explore a few benefits of the conversion.

  1. A lower account balance equates to fewer taxes.
  2. Once your conversion is complete, you will no longer pay taxes on your distributions.
  3. You could pay lower Medicare premiums because of your reduced income. For example, a married couple earning $200,000 may reduce their premiums by 30% or more by moving down to the lowest Medicare tier.
  4. You can contribute to a Roth IRA through back-door contributions.
  5. You will eliminate your Required Minimum Distributions (RMDs). If you keep money in a traditional IRA, you must start withdrawals at age 72, but not so with the Roth IRA.

As a note, the House of Representatives is working on the Build Back Better Act, which will curtail Roth conversions and back-door Roths for high-income earners ($450,000 for couples). The potential phase-out or elimination year is 2031. Stay tuned.

Happy conversions!

The best way to teach your kids about taxes is by eating 30% of their ice cream. ~ Bill Murray

June 10, 2022

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.