Roth Conversions in a Bear Market

For the past decade, we’ve enjoyed a relatively robust bull market. There have been some small ups and downs, but the market has largely continued to go up. This was the longest-running bull market in history, and many investors felt as though it would never end. 

Of course, as financial advisors, we knew that today would come. The market always cycles back to a bear market eventually and, unfortunately, this past week the Dow Jones Industrial Average fell more than 20%. This indicates that we’re officially in a bear market due to a number of factors, including the impact of COVID-19 on the global economy. 

Many investors feared the coming of a bear market, and are now concerned about its long-term impact on their goals. However, in finance and life, there’s a season for everything. The key is to know potential strategies to leverage this particular season to your benefit. During a bear market, there may be several financial moves you can make to help set yourself up for possible future success. One of these moves is to consider a Roth IRA conversion. 

What is a Roth Conversion?

In a Roth conversion, an investor converts their Traditional IRA or 401(k) to a Roth IRA. Traditional IRAs and 401(k)s are tax-deferred. In other words, they’re funded with pre-tax dollars now, but Required Minimum Distributions (RMDs) and other distributions that you take out during retirement are subject to income taxes. 

Many people contribute to tax-deferred accounts to build their retirement nest egg – and it’s no wonder why! Lowering your current taxable income can have many benefits, and the prevalence of tax-deferred account options through employers makes them easy to access. However, a Roth IRA can be equally beneficial. Roth IRAs aren’t funded with pre-tax dollars. Instead, you contribute to them with funds that have already been taxed. So, when you reach retirement, taxes aren’t owed on any qualified withdrawals you may make.

Investors can perform a Roth conversion by transferring their funds from a tax-deferred account to a Roth IRA. They will, however, owe taxes on the funds that are transferred in the tax year the conversion took place. Still, for many who expect their income to continuously grow over the course of their career, paying income taxes now as opposed to later (when they may be in a higher tax bracket) might make sense.

Why Convert Your Roth in a Bear Market?

In our current bear market, we’re experiencing a market sell-off. While markets are down, and tax brackets are lowered due to the Tax Cuts and Jobs Act, you could convert to a Roth IRA and potentially pay notably less in income taxes than you would during a bull market. Essentially, you’d be paying taxes on a much smaller portfolio, which could save you money in the long run. 

Regardless of whether or not you choose to convert your tax-deferred account now or later, there will still be a cost associated with the conversion. Even though the cost of converting may be lower during a bear market doesn’t necessarily mean it’s the right decision for you. For example, if you don’t have the funds to cover the taxes you will owe (without tapping into the newly-converted account), a conversion may not be in your best interest.

As is the case with any financial decision, we believe you want to make sure you get the best possible deal. Although it may not be wise to make decisions about Roth conversions solely based on the market, it can be useful to work a negative situation in your favor when possible. 

The truth is that, when the markets are down, investors may be fearful and want to pull out of the market completely. However, it can be more beneficial to seek out ways to make lemonade out of lemons when it comes to your financial strategy. 

Have Questions?

We are here to help! If you have questions about whether or not now is the right time to perform a Roth conversion, we’d love to hear from you. Contact us today to set up a conversation with our team of advisors. Together, we can help to build a retirement strategy that meets your unique financial needs. 

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