Investors may be on pins and needles as the stock market dances on the precipice of bear market territory, but the decline also brings with it a profound opportunity: the chance for well-positioned investors, even very wealthy ones, to do Roth IRA conversions at a discount.
The beauty of a Roth IRA is that it allows individuals to contribute after-tax dollars and enjoy tax-free appreciation and withdrawals for their entire lifetime, without the required minimum distributions required by traditional IRAs at age 72.
A Roth IRA conversion also gives wealthier investors the ability to participate in lifetime tax-free returns without bumping into IRS income limits for straight-in Roth contributions, which completely eliminate Roth contributions for single filers earning $144,000 of modified adjusted gross income (MAGI) and $214,000 of MAGI for married filers filing jointly.
Even millionaires and billionaires can convert a traditional IRA to a Roth IRA, but they’ll pay income tax on the conversion amount at their marginal tax rate. With the S&P 500 down 17% and Nasdaq plummeting some 30% from their highs, the bear market means an investor’s tax bill will be reduced or that he or she can convert more assets to a Roth for the same tax bill.
“No one is happy seeing the market going down, but everyone is happy to be proactive, so I’m calling all my clients who aren’t in the highest tax brackets and saying, here’s your chance to do a Roth conversion,” Scott Bishop, a CPA, CFP and executive director of wealth solutions at Avidian Wealth Solutions in Houston, told Financial Advisor magazine.
“I have a list of about 25 clients who like to do them and I’m also sitting with a lot of clients who have a lot of cash and I’m telling them now is a good time. Why would you consider doing it in a bull market, if you can convert in a bear market?” asked Bishop.
The bear market also makes the conversions more alluring, because all future gains within the Roth will be tax-free when the market rebounds.
“At these market levels, advisors should be putting money to work, looking for ideas and even looking at some of the bonds that have been hit and converting them to dividend-paying stocks that may recover quicker and tax-free inside a Roth,” he said.
Cody Garrett, a CFP and founder of Measure Twice Financial in Houston, said he likes to plan a gap year after retirement for clients to allow them to minimize Roth conversion tax bills by minimizing taxable income before Social Security benefits and pension RMDs kick in. In effect, investors live off cash in their gap year.
“I work with families who are planning to retire in their mid 50s, before traditional retirement age, so we can end up having over a decade before Social Security, Medicare and pensions kick in. With them, I can talk about ‘now the market is down,’” Garrett said.