“Roth conversion” is a phrase often thrown around, but seldom explained.
Simply put, a Roth conversion allows an investor to convert a “pre-tax” retirement account (a Traditional IRA) into a “post-tax” retirement account, better known as a ROTH IRA.
One of the main differences between a Traditional IRA and a ROTH IRA is the timing of taxes.
In a Traditional IRA, contributions can be made “pre-tax” – meaning they can provide a tax-deduction. However, tax is due when taking withdrawals from a Traditional IRA (usually in retirement).
ROTH IRA contributions are “post-tax” – meaning they do not provide the same tax deduction as a Traditional IRA. However, withdrawals from a ROTH IRA are tax free.
A ROTH conversion converts a Traditional IRA into a ROTH IRA and allows withdrawals to be made tax free. But, there’s a catch…Uncle Sam wants to make sure you pay taxes at some point!
When you convert a Traditional IRA to a ROTH IRA, you will owe taxes on the value of funds you convert at the time of the conversion. This can be a big tax bill, but it may provide an even bigger benefit down the road, since all future withdrawals will be tax free.
So, how can market volatility provide an opportunity for a Roth conversion?
Market pullbacks may present an excellent opportunity to convert to a ROTH IRA. If the value of your Traditional IRA is lower now than at the start of the year, the corresponding tax liability associated with a conversion will also be lower.
Following a conversion, investors may benefit from any subsequent market rebound with tax-free appreciation.
Finding a silver lining amidst market volatility can be difficult, but true financial planning can provide opportunities in all market environments to improve your overall financial life.
- Current clients who would like to explore the possibility of a Roth conversion, reach out to your advisor.
- Not a TVAMP client but want to discuss Roth Conversions or other strategies? Schedule your 15-min introductory call below.
Become empowered with a plan
We remove the complexity
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.