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In this clip from “Financial Planning Q&A 60” on Motley Fool Live, recorded on Jan. 26, Motley Fool contributors Robert Brokamp and Dan Caplinger discuss why a Roth conversion amid a market downturn can be beneficial.
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Robert Brokamp: One possibility is now could be a time to do a Roth conversion. We’ve talked before on the show why Roth assets make sense particularly now. We are at tax rates that are at levels not seen in decades in terms of being very low. Tax rates are expected to go up. In fact, they will go up at the end of 2025 when the tax law that was passed in 2017 sunsets. But, of course, people think taxes are going to go up anyhow because there are so many government deficits, Medicare is underfunded, Social Security’s underfunded, the money’s got to come from somewhere. Having Roth assets is great because you pay taxes today when your tax rate may be lower and the assets grow tax-free, as long as you follow the rules. If you expect to be in the same or a higher tax bracket in the future, Roth makes sense. Why would you do a Roth conversion now? When you convert assets from Traditional to Roth, the amount you convert gets added to your taxable income this year. If you had an account that was, let’s say $100,000, but it’s now down to $80,000 and you make that conversion, you are converting at a lower amount, that adds less taxable income to your income this year. You’re converting when stocks are down and then you ideally will benefit when they eventually recover. Those are some few thoughts about that. Dan, what are your thoughts on doing Roth conversions now? If you have questions about Roth conversions, specifically, feel free to ask those in the Slido as well.
Dan Caplinger: Yeah, the reason we brainstormed what we wanted to talk about this time and we’re always looking out when there’s a market downturn. We’re always trying to figure out. People are nervous. They want to do something. They want to do something that’s productive, and so much of the investing advice that you hear is geared toward sitting on your hands, having trust in a long-term strategy. That’s hard to do. A lot of people, I am one of them, like to have something to do in times like this. I was racking my brain, thinking, what is an actual productive thing that you can do? Selling stocks at the bottom, a bad idea, that’s not what we want to do. But, taking a look at something that might be able to get your taxes to look a little bit better is definitely something that seems to fit the bill. It’s interesting because when you put in place this idea, the strategy of I’d like to convert some of my IRA assets into Roth IRA assets, in a sense, you’re going against your general preference for seeing the value of your portfolio go up. Because, really, for a Roth conversion strategy, if you knew in advance that you’re going to have a short-term drop in the market followed by a nice quick rebound, then you would pick that 99 times out of a 100 to be the timing that you would do for your Roth conversion. Because with the Roth conversion, you can keep the same assets, keep the same stocks, keep the same investments, you just move them over from a tax-deferred account to a tax-free account. When you make that move, the tax consequences are based on the minute-by-minute valuation at the time that you do it. Whether it’s, we’ve talked about this before, different brokers, some of them do end-of-day calculation. Other brokers will give you the value at the time that you actually do the conversion transaction, whatever time of day that might be, if the market’s open. They’ll take the value of the stocks that you convert. It’s an opportunity. If you have that conviction about your investments, if you are convinced that the businesses underlying these fallen stocks are still strong, that the businesses will rebound and continue to thrive, that the stocks therefore should be able to regain ground over the longer time horizon that you have. Then, times like this, can be the best time to do these things. Because of the way that the IRS has recently changed its rules, it used to be you didn’t have to time it perfectly. If it turned out you timed it badly, you could get a do-over. They’ve wised up on that. They don’t let you do that anymore. You have to do things yourself, and sure, there’s no guarantee this is the bottom. It may be if you wait, you’ll get a better deal for doing a conversion down the road. But it may well be that, if today’s rebound starts to gain ground, then it’s a situation where you might look back and say, “Boy, I wish I had converted at that point instead of waiting until stocks were more expensive and now I have a higher tax bill as a result.”
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