By CD Moriarty
Warner Bros/courtesy Everett Collection
Here’s a way to take advantage of the stock market’s dive: Consider doing a Roth conversion.
You take the retirement monies you currently have in traditional IRAs and move them to a Roth IRA. Given how the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +1.20% and the S&P 500 index /zigman2/quotes/210599714/realtime SPX +0.83% have plunged by about a third in recent weeks, your retirement account is worth a lot less than it once was. It also means your tax bill for a conversion will be less than when the market was higher just a few weeks ago.
A conversion is often touted as the way to avoid ever being forced to take a required minimum distribution (RMD) that is part of a traditional IRA. After a Roth IRA has been open for five years, it also allows you leave a tax-free inheritance to your heirs. Plus, when you take out money you do not pay taxes, another great advantage.
But before you decide to do a Roth conversion, consider these three questions.
1. Do you have the cash to pay the taxes now?
How much cash do you really have? Remember, you will have to pay taxes on this move. As the coronavirus pandemic shuts down businesses and is expected to cost millions their jobs, even temporarily, leave yourself plenty of wiggle room before you part with your cash for the Roth conversion taxes.
Without the cash to pay those taxes, you are taking money from a low-performing investment to pay this year’s taxes. But the ripple effect is even bigger. There will be even less equity to build for the long term. Plus, using the IRA funds to pay taxes now will not only dwindle your retirement funds but will count as a taxable withdrawal for 2020. This causes more income taxes and possibly a penalty if you are not over 59 ½ this year.
2. Do you have a Roth option through work?
Many companies have a designated Roth 401(k) option for retirement monies subject to the same rules as a traditional 401(k). Plus anyone with earned income can contribute to a Roth IRA within certain income limits. Your best strategy may be to start now making ongoing contributions to your Roth option at work or a Roth IRA. When you retire, you will have a mix of investments to choose from to make your retirement withdrawals without making a conversion.
Now that the age for taking the RMD on your IRA has moved to 72, from 70 ½, the tax impact of those payments may be less. This may impact your decision-making process more than what the stock market is doing currently.