Roth Conversion in Market Downturn: Heads You Win, Tails The Government Loses!

By Jeffrey Levine, IRA Technical Expert
Follow Me on Twitter: @IRAGuru4EdSlott

As you are probably aware by now, the stock market has been on a bit of a downturn as of late (to say the least). It’s no fun to lose money in the market – or anywhere else for that matter – but if you’re investing for the long haul, losses are bound to happen from time to time. If you’re quick on your feet, however, you can turn the proverbial lemons into lemonade by taking actions now to make the most of a bad situation.

Case in point…  a Roth IRA conversion. When you execute a Roth IRA conversion, you pay tax on the fair market value of the assets that you convert. A few weeks ago, your IRA may have been worth $100,000, so converting it completely would have added another $100,000 to your income tax bill. Now, however, that account may be worth only $80,000. As a result, converting now as opposed to two weeks ago could save you about 20% on your tax bill.

What if the market goes even lower from here though? What if you’re account drops to $60,000? Are you stuck paying the tax bill on $80,000? Absolutely not. A Roth conversion comes with a money-back guarantee. If you’re not happy with your conversion for any reason – including a drop in your account value – you can recharacterize (a fancy tax word for undo) the conversion at any time up until October 15 of the following year. By doing do, you eliminate the tax bill that would have otherwise been due on the converted amounts.

What if, however, this is the bottom and the market rebounds only higher from here. If you convert now, you can enjoy all that appreciation, tax free, inside your Roth IRA. If you don’t convert and that happens, you’ve lost out on the opportunity to convert while the market’s down. There’s no October 15 date to retroactively complete a Roth conversion!

So by converting now, it’s kind of a heads you win, tails the government loses scenario. If your account drops further, you can recharacterize your conversion and eliminate your tax bill. If it goes up from here, you can enjoy that tax-free appreciation and keep it all out of Uncle Sam’s hands.

Of course, just because your account dropped in value doesn’t mean you should execute a Roth IRA conversion. It still has to make sense in the course of your overall tax plan. That said, if a Roth conversion does make sense for you, doing so today is probably a lot more beneficial than doing so even just a few weeks ago.