Investors may be on pins and needles as the stock market dances on the precipice of bear market territory, but the decline also brings with it a profound opportunity: the chance for well-positioned investors, even very wealthy ones, to do Roth IRA conversions at a discount.
The beauty of a Roth IRA is that it allows individuals to contribute after-tax dollars and enjoy tax-free appreciation and withdrawals for their entire lifetime, without the required minimum distributions required by traditional IRAs when their owners turn 72.
A Roth IRA conversion also gives wealthier investors the ability to participate in lifetime tax-free returns without bumping into IRS income limits for straight-in Roth contributions, which completely eliminate Roth contributions for single filers earning $144,000 of modified adjusted gross income (MAGI) and $214,000 of MAGI for married filers filing jointly.
Even millionaires and billionaires can convert a traditional IRA to a Roth IRA, but they’ll pay income tax on the conversion amount at their marginal tax rate. With the S&P 500 down 17% from its highs and the Nasdaq plummeting some 30%, the bear market means an investor’s tax bill will be reduced or that he or she can convert more assets to a Roth for the same tax bill.
“No one is happy seeing the market going down, but everyone is happy to be proactive, so I’m calling all my clients who aren’t in the highest tax brackets and saying, here’s your chance to do a Roth conversion,” says Scott Bishop, a CPA, CFP and executive director of wealth solutions at Avidian Wealth Solutions in Houston.
“I have a list of about 25 clients who like to do them, and I’m also sitting with a lot of clients who have a lot of cash, and I’m telling them now is a good time. Why would you consider doing it in a bull market if you can convert in a bear market?” Bishop asks.
The bear market also makes the conversions more alluring, because all future gains within the Roth will be tax-free when the market rebounds.
“At these market levels, advisors should be putting money to work, looking for ideas and even looking at some of the bonds that have been hit and converting them to dividend-paying stocks that may recover quicker and tax-free inside a Roth,” he says.
Cody Garrett, a CFP and founder of Measure Twice Financial in Houston, says he likes to plan a gap year after retirement where investors effectively live off cash. That allows the clients to minimize their Roth conversion tax bills by minimizing taxable income before Social Security benefits and pension RMDs kick in.
“I work with families who are planning to retire in their mid-50s, before traditional retirement age, so we can end up having over a decade before Social Security, Medicare and pensions kick in,” Garrett says.
“If we’re going to convert this year anyway, I’d rather do it now than wait until the end of the year, when the market may rebound,” adds Garrett, who says most of his clients who do conversions strategically reduce their tax bracket to a 10%, 12% or 22% bracket for the year.
For clients with larger sums to convert, Garrett runs an illustration showing what conversions will cost in a tax bill each year. The illustration also shows investors how much time they have to fully convert to a Roth IRA before mandatory income like Social Security benefits or RMDs commence.
“We want to pay higher taxes early in gap years to reduce the tax bill when mandatory RMDs kick in. I call it smoothing out their tax ride,” Garrett says.
“I make them pay more taxes through conversions early, so once they hit age 72 there is less money to take in RMDs. We anticipate typically a 30% to 50% reduction in lifetime taxes by implementing Roth conversion strategies, cutting their taxes in some cases by a million dollars,” Garrett says.
Peter Tanous, founder and chairman of Lynx Investment Advisory LLC in Washington, D.C., says Roth conversions during a bear market also give advisors the opportunity to rebalance client portfolios.
“Particularly in the growth area, many stocks that were overvalued have gotten killed, and now is the time to pick up some really good names and salt them away in a Roth. This isn’t a recommendation, but for instance, Disney has really gotten whacked. It’s a core holding for many portfolios and you can now buy it at a 20% to 30% discount, with the understanding that stocks have risen in all 20-year periods in history. For the right clients, there are many opportunities out there,” Tanous says.