Timing can be critical with Roth IRA conversions. In that light, the recent market decline definitely made the prospect of converting regular IRA assets to a Roth more alluring for those investors who are well positioned, advisors said.

Tax-free growth has made Roths an effective retirement planning tool since Congress created them in 1997. With Nasdaq retreating more than 17% this year, the market declines offer the right investors three additional conversion incentives: a lower conversion tax bill, the ability to convert more assets and the prospect of watching the market rebound tax free.

“The market is down, so the tax liability of a conversion will be cheaper now than last year, depending on your asset allocation. We are definitely pounding the table for those in their gap years to consider a Roth conversion now,” said Brad Lineberger, founder and president of Seaside Wealth Management in Carlsbad, Calif.

In fact, years before clients reach their gap years—between age 60 and 72, when required minimum distributions kick in and add to income—Lineberger said he advises investors to prepare to minimize their Roth conversion tax bills by socking away cash reserves they can tap instead of using taxable assets like retirement plan distributions and IRAs. This allows clients to reduce their adjusted gross income (AGI) to 12% for at least one year to make conversions more affordable, he said.

When you convert to a Roth IRA, the converted IRA balance is treated as if it were a distribution. This income must be included on investor’s tax return in the year of conversion. So, a 12% federal tax bracket makes the cost of a conversion 12% in federal taxes, Lineberger said.

In the years leading up to retirement “we coach folks to delay Social Security and build up their cash and their taxable accounts, so they can live on these assets during a few years of retirement in order to keep their tax bracket lower. Anyone we can get to the 12% [federal] tax bracket, even if that’s just for one year, we’re definitely advising them to convert,” Lineberger said.

“The eventual market recovery will happen inside the Roth, so you will enjoy tax-free distributions in the future,” he added.

To achieve a 12% tax bracket in 2022, single filers need to have adjusted gross income (AGI) of $55,900 or less and married taxpayers filing jointly need to have AGI of $83, 550 or less.

The strategy can be tricky and not everyone can achieve such a low federal bracket in their gap years, especially those who rely on pension or IRA withdrawals or who start taking Social Security benefits, he admitted.

“You have to be very intentional in building up cash reserves to live on to reduce your declared AGI, even if it’s just for the year you intend to convert, but we have a number of clients, even high-income clients, we’ve helped position to take advantage of this downturn,” Lineberger added.

As a general rule of thumb for investors who can assume their tax bill will be the same now as it is after retirement, the tax on a Roth conversion will be proportionately less during the downturn, said Jame G. Blase, a tax attorney, advisor and principal of the law firm Blase & Associates LLC in Chesterfield, Mo.

If the market decline is 20%, for example, the tax to convert “an $80 gain will generally be 20% less than the tax on a $100 gain,” Blase said. “One thing to bear in mind, however, is that we cannot just assume the market will not go even lower for a period of time, in which case the investor may end up overpaying by converting now.”

Retired clients, whose tax brackets are not likely to go lower in the future, are generally the best candidates for conversions, he said.

“If the investor is currently working, and therefore in a higher income tax bracket than he or she may be after retirement, this may not necessarily be a good time to convert,” Blase added.

The tax bracket difference between working people and retired people should be a main consideration that some advisors miss, he said. 

Advisors “who preach that tax brackets are going to rise in the future, so therefore now is the right time to do Roth conversions, are generalizing. I never advise working clients to do any significant Roth conversions,” Blase added.

Hratch J Karakachian, a CPA and tax attorney in Glendale, Calif., said market downturns can shave the tax bill for Roth conversions significantly for the right investors. “It’s a really good little downturn we’re in right now and that can help,” he said.

The California tax attorney said that based on his calculations, if a client owned a $100,000 portfolio that declined 30% to $70,000 and the client’s combined federal and state tax bracket is around 33%, he or she could save about $7,000 doing the Roth conversion.

“The tax on their conversion before [the market decline] would have been about $30,000 and it decreases to $21,000 after. The hope and goal is for the position to go back up, so that the tax is offset and gains are tax-free,” Karakachian said.

He said it’s important, however, to remind investors that they don’t have to sell assets to do a Roth conversion and that once done, Roth conversions are now permanent. “I warn clients that there are no do-overs,” Karakachian said.