Dear Mr. Market:
With regard to investing, sometimes no action is the proper action…but not always!
Now might be a very good time for a very specific act: converting assets from a traditional IRA to a Roth IRA. Here are a few reasons why:
THE MARKET IS LOW
Predicting when the market will hit its final low point is impossible, but history says the market will recover and start growing again. If you convert assets at depressed levels before the market recovers, you get the benefit of the bounce back inside the Roth. Say you have holdings in a traditional IRA that were worth $125,000 at the market peak and they are now worth $95,000. You could convert the $95,000 to a Roth and pay taxes on the conversion for that amount. When the assets recover to pre-bear levels, your Roth is now worth $125,000.
THE CURRENT TAX ENVIRONMENT IS FAVORABLE
The general logic behind converting is that it makes sense if you think tax rates (especially your own) will be the same or increase over time. Personal income tax rates are historically low right now. With the new $2 trillion CARES stimulus, and an already high government budget deficit, what’s the likelihood rates increase in the next several years? The CARES Act also suspended required minimum distributions from traditional IRAs for 2020. If taking that distribution (and paying taxes on it) was already part of your plan for the year, consider converting at least some of those assets to a Roth.
PARTIAL DEFENSE FOR INHERITED ASSETS
The recently passed SECURE Act changed the way non-spouse IRA beneficiaries have to take future distributions. Instead of being stretched over their lifetimes, they now have to be taken within a 10-year window (save for a few specific exceptions). With a traditional IRA, those distributions will all be taxed as regular income for the person who inherited the assets. From a Roth, beneficiaries will still be stuck with the 10-year distribution window, but there will be no taxes on what they withdraw. They could conceivably allow the Roth to grow for 10 years without touching it, then take out the whole thing at once.
There are factors to consider before jumping into a significant Roth conversion. Whatever amount you convert will be taxed as regular income that tax year, so working with your advisor and your CPA to determine the right amount for you is very important. For many investors, a conversion plan carried out over multiple years makes sense. Reversing Roth conversions was outlawed by the Tax Cuts and Jobs Act of 2017, so you can’t change your mind once assets have converted.