Roth Conversion in a Down Market
Is a Roth conversion in a down market is beneficial because the converted funds will participate in the recovery? OR, does it depend on how the taxes are paid and the opportunity cost of the cash used to pay taxes?
For example:
Client has a $100K Traditional IRA. Balance declines to $50K due to market performance. Convert to Roth while at $50K and pay 20% tax rate out of pocket ($10K cash). Roth recovers to $100K balance.
I think the math hinges on the $10K of cash that was used to pay taxes, right? If that were to be invested and experienced the 100% return like the converted Roth balance, then would it be a wash?
Thanks!
Permalink Submitted by David Mertz on Fri, 2022-10-14 20:47
It would not be a wash. Without the Roth conversion but investing the cash the same as the investments within the traditional IRA, the client would have inside the traditional IRA $100,000 of tax-deferred funds plus outside the IRA $20,000 of cash minus the tax on the $10,000 gain. Assuming a 20% tax rate on the traditional IRA and a 15% tax rate on the gains outside the IRA, that would be an after-tax value of $80,000 in the traditional IRA plus an after-tax value of $18,500 outside the traditional IRA for a total after-tax value of $98,500, with future gains being taxable. With the Roth conversion there would be $100,000 in the Roth IRA and no future tax liability (assuming no distributions until distributions are qualified).