Recent events have caused the value of retirement accounts to plummet because of downturns in the stock market.  There may be a silver lining if you have a traditional IRA.  This may be a great opportunity to convert your traditional IRA to a Roth IRA and reduce your overall tax burden.

Roth VS. Traditional IRA

The differences in a traditional and Roth IRA are as follows:

Traditional IRA.  Contributions to a traditional IRA are deductible, depending on your modified adjusted gross income, and whether you or your spouse participate in another qualified plan such as a 401(K).  Any growth in these accounts are tax deferred.  In other words, taxes will not be paid on these funds until they are withdrawn.  You will be required to begin taking requirement minimum distributions at 72-1/2 years of age and paying tax on the distribution.

Roth IRA.  Roth Contributions are not tax deductible, however, withdrawals including any growth will be tax free as long as your age is 59-1/2 or older, and the account has been open for a minimum of five years.  (A few exceptions exist for early withdrawal)  There is not a required minimum distribution requirement after you reach age 72.  Both the Roth and the Traditional are subject to contribution limits as stated above in reference to adjusted gross income etc.

In a nutshell, you either pay taxes on the seed (original Roth Contribution) or on the harvest (Traditional contributions plus growth).  Fortunately there is no income limitation to do a conversion.

Tax Saving Opportunity.  So the silver lining with the downturn in the stock market can potentially be utilized with a conversion from a Traditional IRA to a Roth IRA.  If your retirement account has lost value, converting while it is low will minimize your tax liability.  The other benefit is receiving any growth in the fund tax free.  You do need to think carefully through the details before you convert, and definitely consult with your tax and investment advisors.

Can you afford the tax bill now?  Tax will need to be paid in the year you convert.  Do you have enough cash to pay the tax bill?  The more you convert, the higher your taxable income will be, resulting in higher taxes.  Again, consult experts to help you make the right decision.

What is the time frame of your retirement?  If you are very close to retiring you may not want to consider a Traditional to Roth conversion.  The idea of the conversion is to allow it to grow tax free.  If you are only a few years away from drawing the retirement out, you may not want to do it now since there will be less time to grown tax free.  You may consider doing a smaller portion and holding it until the latter end of your retirement to reach a similar result.  Many likely scenarios exist.

Many other factors need to be considered before completing an IRA conversion.  If this is something of interest to you please reach out and see if the conversion is right for you.