By LouAnn Schulfer, AWMA®, AIF®
Accredited Wealth Management AdvisorSM
Accredited Investment Fiduciary®
Investors generally do not like market volatility like we experienced in February and March of 2020, meaning volatility to the downside. Knowing this, we were vigorously calling our clients to see if any were experiencing anxiety or concern; we discussed how their money is invested for the longer term. We went on to discuss two significant opportunities for some: adding money to their investments to “buy on the dip” of the market, as well as ROTH IRA conversions.
A ROTH IRA conversion is when money is moved from a traditional IRA to a ROTH IRA. The dollars converted are counted in income tax calculations in the year of the conversion. For example, if you convert $40,000 in 2020, $40,000 will be added as taxable income to your 2020 returns. Therefore, being prepared to pay the tax is one consideration as to whether a conversion is suitable for you. It is generally advisable and the least complicated to pay the tax from outside of the IRA rather than a withholding. Doing so will also enable more dollars to be invested into the ROTH account and for people under 59 ½ , a withholding would count as a premature distribution resulting in IRS and state tax penalties. Assessing how additional taxable income affects one’s overall tax situation is also very important: we ran into some instances with clients where the added income would increase health insurance or Medicare premiums or affect other tax credits or implications.
Among my clients, we ended up converting about a half million dollars from IRA to ROTH in that short period of drawdown. The timing resulted in “selling” from traditional IRAs at lower market values, immediately reinvesting into their ROTH accounts, and “buying” at the same market point where the ROTH money had the opportunity to recover value and continue to grow on a tax-deferred and eventually tax-free basis for withdrawals (as long as IRS rules are followed). Factoring in an approximately 20% gain from the low market values, that $500,000 of IRA money is now worth about $600,000 of ROTH IRA dollars with continued potential for tax favored growth! A great example of how volatility can present opportunity!
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. A ROTH IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply. Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include 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.