In the midst of COVID-19 and the resulting stock market crash, many investors are wondering whether they should continue contributing to their retirement account, or whether they should look into a Roth conversion.
A Roth conversion is where you would take the pre-tax dollars currently in your retirement account (whether a traditional IRA or a qualified retirement plan sponsored by your employer) and pay tax on them while they remain in a tax-free Roth account.
Considering the current market and “low” tax rates, it may be a good time to take advantage and make a Roth conversion.
Tax rates are at an all-time low and while the funds in your retirement account may have taken a hit, if you convert on the current amount, you’ll pay less in tax.
The Benefits of Roth Conversion
Here are some additional benefits to making a Roth conversion:
• There is no income limit and no limit on the amount to be converted for individuals to do a Roth conversion.
• The earnings after you convert will continue to grow tax-free, indefinitely.
• You will avoid the required minimum distributions.
• The IRS treats all of your Roth IRAs as one account– so if you had a Roth account more than five years old, the IRS would treat the new one as if it were also more than five years old.
The Downfalls of Roth Conversion
However, there are also some downfalls to take into consideration:
• If you do not have the funds outside of the retirement account to pay the tax, it does not make financial sense to make the conversion.
• You can no longer “go backward” and recharacterize a Roth IRA conversion from a traditional IRA (a maneuver banned by the Tax Cuts and Jobs Act of 2017).
• If you have dependents applying for financial aid, Roth conversions will need to be included as income reported on the financial aid form.
It is important to note that some have “advised” that you can take withdrawals and stretch tax payments over three years by contributing the withdrawal to an IRA.
However, this strategy has not been given the official “OK” by the IRS and could result in a costly penalty for the taxpayer.
Before making a decision, consider these…
When deciding whether or not it is a good decision for you to make, you’ll want to take into account the two main considerations:
1. Your current tax rate versus what you or your beneficiaries will pay on withdrawn funds in the future.
2. The value of your assets in your retirement account.
As with any traditional retirement account, you should always consult with your tax advisor prior to making any changes or deciding to make a Roth conversion.