Roth IRA Conversions in a Down Market: 6 Things to Consider

The stock market was already experiencing volatility before the crisis in Ukraine. The major market indexes are lower so far in 2022. For clients considering a Roth IRA conversion, this might be an excellent time to move forward.

Clients who might benefit from a Roth IRA conversion in a down market include:

Those looking to manage their taxable income in retirement.
Those who expect to have income at or above their current level in retirement.
Those who believe tax rates will be higher in the coming years.
Those looking to minimize the taxes their kids or other non-spousal heirs will need to pay on inherited IRA assets.

Does a Roth IRA conversion make sense in a down market environment like this? In the gallery above are some things to consider in working with your clients. As with Roth IRA conversions in any market environment, your clients depend on your expertise to ensure the conversion is done correctly and is consistent with their overall financial planning objectives.

Roger Wohlner is a financial writer with over 20 years of industry experience as a financial advisor.

1. Convert a larger portion of the traditional IRA.

Down markets present an opportunity for clients to convert a larger percentage of their traditional IRA to a Roth. If they would have normally done a $100,000 conversion from a traditional IRA worth $1 million, that same $100,000 conversion would represent a higher percentage of the traditional IRA if the account value has declined to $900,000.

If your client’s plans call for aggressively converting funds to a Roth IRA, they might consider converting a larger amount, perhaps $125,000 or $150,000 in this example. Their goals for having money in a Roth might include tax diversification of their retirement accounts or estate planning.

The opportunity in a down market environment is that the amount converted will have the opportunity to grow inside the Roth IRA once the markets presumably turn around.

(Image: Adobe Stock)

2. Estate planning

Regarding estate planning, the case for converting in a down market can be as simple as the fact that money in a Roth IRA is not subject to required minimum distributions. This allows the money to grow tax-free for your client’s use or to go to their beneficiaries upon their death. Converting under these circumstances could result in a larger amount in the Roth IRA over time.

With the advent of the Secure Act, Roth IRAs have the added estate planning advantage of tax-free withdrawals for non-spousal beneficiaries as long as the account owner has satisfied the five-year rule prior to their death. If this is part of the goal of doing Roth conversions, it makes sense to convert as much as feasible as soon as is feasible to ensure that all conversions satisfy their own five-year rule clock.

This can be a good argument for converting a bit more than normal in a down market to get a larger percentage of the traditional IRA money converted to their Roth IRA.

(Image: Shutterstock)

3. The client’s current tax situation

Regardless of the direction of the market, it is always important to take the client’s tax situation into account. Whether the stock market is up or down, they are required to pay taxes on the amount converted during the year.

A “perfect storm” in a positive way for Roth IRA conversions is a situation where your client’s income is lower than normal and the market is down in the same year. The income generated by the conversion will have a smaller tax impact, and they will be able to convert a higher portion of the traditional IRA to a Roth without incurring a significantly higher tax bill.

(Image: Shutterstock)

4. The client’s future tax situation

The client’s projected tax situation in future years is always a key planning consideration. Converting a higher portion of their traditional IRA now can serve to reduce the level of future RMDs. For clients who don’t need the money from their RMDs to support their retirement lifestyle, having more in their Roth IRA makes a lot of sense.

It’s also important to look at what the client’s future tax situation might be from an income perspective. It’s not uncommon for many clients to be in a high tax bracket in retirement between Social Security, a pension and the tax impact of RMDs. They may have also earned income from employment or self-employment on a full- or part-time basis. If the client is married, it's important to look at any income from a non-retired spouse as well, if applicable.

The flip side of this for clients who are retired is weighing the impact of doing a larger Roth conversion in a down market and incurring more income. For clients on Medicare, this extra income could cause their premiums for Medicare Part B to increase in a subsequent year due to this extra income.

(Image: Shutterstock)

5. Be sure the client has sufficient cash for taxes.

Regardless of how advantageous a Roth IRA conversion is for your client under any market conditions, it’s critical to work with them to ensure they have enough cash outside of their IRA to cover the taxes on the conversion. If they don’t, this process can become very expensive, as they may have to withdraw funds from their traditional IRA, incurring more taxes and potentially an early withdrawal penalty if they are under age 59½.

(Image: Adobe Stock)

6. Beware of tax-loss harvesting and wash sales.

A down market might present opportunities to do tax-loss harvesting with some of the client’s taxable investments. Assuming that you advise the client on all of their holdings across all accounts, there is little danger of triggering a wash sale.

But if, for whatever reason, the client or another advisor oversees some of their assets, there is a risk of triggering a wash sale that would negate their ability to use some of the tax losses they have realized. Perhaps the most common risk here is buying a security in the course of the Roth conversion within the 61-day wash sale period that is substantially equal to one that was sold in the tax-loss harvesting process.

(Image: Shutterstock)

Roth IRA Conversions in a Down Market: 6 Things to Consider

Roger Wohlner

How to Eliminate Tax on Some Roth IRA Conversions

More on this topic

It’s Not Too Early to Start 2024 Tax Planning

An Asset Manager's Key to Boosting After-Tax Wealth

Bond Ladders Gain Traction in Direct Indexing

CFP Board Picks 7 Best Retirement Research Papers of 2023

1. Convert a larger portion of the traditional IRA.

2. Estate planning

3. The client’s current tax situation

4. The client’s future tax situation

5. Be sure the client has sufficient cash for taxes.

6. Beware of tax-loss harvesting and wash sales.

8 Tax-Loss Harvesting Tips for 2024

10 Ways You Save Your Clients Money

9 Tax-Saving Strategies for Year-End 2023: Advisors' Advice

20 Popular Funds That Could Sock Clients With Hefty Tax Bills

Featured Resources

Candid Conversations: Couples, Money & Conflict

Helping Your Clients Make a Greater Philanthropic Impact

Index Year End Review: 2023

RIA Investment Trends

Roth IRA Conversions in a Down Market: 6 Things to Consider

Share with Email

Thank you for sharing!

More on this topic

1. Convert a larger portion of the traditional IRA.

2. Estate planning

3. The client’s current tax situation

4. The client’s future tax situation

5. Be sure the client has sufficient cash for taxes.

6. Beware of tax-loss harvesting and wash sales.

Featured Resources

Connect with ThinkAdvisor