To date, 2020 has been a rough year for investors with the stock market well off its highs reached in February. You may have a number of clients for whom a Roth conversion makes sense. Financial advisor Jim Blankenship, CFP, EA of Blankenship Financial Planning feels it can be beneficial to do a Roth conversion when account values are low. Why? “Because the reduced value of your holdings will likely increase significantly as the momentum swings upward,” he explains. “This way, by the end of the year, your converted money could be worth much more than the amount you have to pay taxes on.”
Another way to analyze this is that with these lower account valuations, you can potentially convert a higher percentage of the account than you could when the account value was higher for the same amount of tax. For example, if the value of your traditional IRA stands at $250,000, a conversion of $50,000 would equal 20 percent of the value of the account. If the account value stood at $200,000, this same $50,000 would represent 25 percent of the account value. Yet, the tax liability would be the same in both cases.
For those clients for whom a Roth conversion already makes sense, you might say they are converting at a bargain rate.
2020 – A Perfect Storm
Even beyond the decline in the stock market, 2020 is shaping up as a “perfect storm” in terms of a number of factors coming together that favor Roth conversions. These include:
- Continued lower tax rates due to the Tax Cut and Jobs Act that went into effect for the 2018 tax year. Tax rates for most of your clients are lower than prior to this, making a conversion generally cheaper from a tax standpoint.
- The waiver of required minimum distributions (RMDs) for 2020 as part of the CARES Act legislation. This provision allows anyone otherwise subject to taking their RMD in 2020 to waive the requirement for 2020. This is advantageous relative to Roth conversions in a couple of ways. First, the amount not taken adds to the amount available to be converted to a Roth. Similar to the example above, if the client’s RMD would have been $50,000, this amount could be converted to a Roth with no increase in the client’s tax bill over and above what it would have been for the RMD. Additionally, this amount is now in a Roth account and not subject to RMDs in subsequent years.
- The SECURE Act, passed at the end of 2019, changed the rules for most non-spousal beneficiaries of inherited IRA accounts. Instead of being able to stretch out the benefits of tax-deferral in these accounts, they now need to take a full distribution within ten years. This can mean a hefty tax bill for these heirs, drastically reducing the amount of their inheritance. Part of your client’s estate planning might now include a Roth conversion if their goal is to pass their IRA on to their heirs tax-free.
A Roth IRA can be an advantageous move during a market decline, especially in 2020. It is prudent to discuss this idea with clients who might benefit.