I often discuss the current, temporary challenges facing the stock market, BUT today I’m going to discuss an opportunity provided by challenged stock markets.
For retired clients, I often use Roth conversions as a way to maximize the after-tax value of their wealth and retirement income. Stock market corrections can make those conversions even more valuable!
Periodic losses and drawdowns are simply a reality we must be willing to tolerate if we desire long-term growth. So, we might as well take advantage of opportunities presented in declining markets. Some examples of opportunities that arise: tax loss harvesting, additional contributions to portfolio, rebalancing, and, today’s topic, Roth conversions.
When folks retire, their income *usually* drops and they often fall in a relatively low tax bracket before they begin collecting Social Security and are forced to begin taking taxable retirement plan distributions at age 72 (yet another reason to potentially delay Social Security until age 70 for many households).
This creates a wonderful opportunity to start converting chunks of pre-tax money to a tax-free Roth IRA at a low tax rate. Essentially, the investor benefits from a tax deduction at a higher tax rate while working then withdraws / converts the funds at a lower tax rate before their tax rates jump higher again in the future.
Below is a simple illustration comparing a hypothetical conversion versus no conversion (assuming a higher future tax rate).
For certain households, I’ve projected we’ll be able to convert almost $1,000,000 to their tax-free Roths at low tax rates throughout their early-retirement years!
So, this can be a wonderful planning opportunity regardless, but it is even more attractive during bear markets. Why? As Michael Kitces puts it…
“Because for those investors who were planning to make a Roth conversion anyway, a declining market effectively puts the conversion ‘on sale’ at a (hopefully) temporarily depressed value.
…when an IRA’s value is ‘temporarily depressed’ in a bear market, it becomes possible for an individual to convert a larger percentage of their pre-tax account to a Roth account, making it possible to shift a larger portion of the future growth of the account into a Roth… without moving into a higher tax bracket as a more sizable portion of the account is converted.”
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.
Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here. Any forecasts made are the opinion of the author. Markets are famously difficult to predict precisely because so many factors are involved…particularly over short time periods. And many folks don’t have the patience to see long-term forecasts play out because so much can happen in the interim..
This is not investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed.
Views provided here are current only as of the moment of posting and are subject to change at any time without notification