Market Declines and Roth Conversion Opportunity

The recent market decline may present a strategic planning opportunity. Roth IRAs differ from traditional IRAs in that any growth and distributions are received tax-free. The ability to receive a lifetime of investment growth tax-free is a tremendous benefit. So much so, that government rules limit who can directly contribute based upon one’s income. The 2022 limit for married filing jointly is $204,000 of modified adjusted gross income. For single, head of household, or married filing separately the limit is $129,000.

However, the rules presently allow for anyone to convert a traditional IRA balance to a Roth IRA. The income limits don’t apply to conversions, only to contributions. You can also do a conversion within your 401(k) or other company-sponsored retirement plan so long as the plan permits. The ability to convert may change in the future as the original draft of the Build Back Better bill proposed to limit Roth conversions based upon various factors such as income or accumulated wealth. Therefore, the future of Roth conversions is uncertain, but for the time being, they are still permitted.

The way it works is that you file the appropriate paperwork with the administrator or recordkeeper of your account to convert pre-tax sourced money (or even after-tax contributions to a retirement account/plan) to Roth. There aren’t any penalties to make a conversion. However, you will owe income taxes on the amount that’s converted in the year of conversion. Also, it’s not necessary to convert all your traditional balances at one time. You’re free to do it in chunks.

So why does the current market decline present an opportunity? Because all the gain that occurs when the markets eventually bounce back will be inside the Roth account. Thus, you’re taking advantage of the current market conditions to get a higher percentage of your money to a tax-free state. This has the potential to significantly reduce your lifetime taxes. That said, this won’t be a good immediate move for everyone and should be evaluated on a case-by-case basis. Be sure to consult with your financial planner and also your tax professional to understand any tax or planning implications prior to taking any action.


Written By: Aaron M. Puttroff't,a%20%E2%80%9Cbackdoor%E2%80%9D%20Roth%20IRA

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