Down Market Plus – Roth Conversions

Why you should consider moving assets to a tax-free Roth account while income tax rates are low and stocks are down

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Instead of wasting time looking at how much your stock positions have declined since the peak of the market, you should use this downturn to your advantage. One way is to evaluate the tax implications of converting some of your traditional IRA (or all of it) to a Roth IRA. Moving traditional IRA assets to a Roth IRA creates a taxable event based on the current value of those assets. All of the growth that occurs in the Roth when the stock market recovers will be tax free once you are age 59 ½ and the conversion is five years old. This allows us to capture the temporary lower value of these assets for tax purposes.

The conversion will create a taxable event in 2011, requiring payment of income taxes on the amount you convert. Yes, the payment of taxes in this year is the downside. You will need to carefully consider the impact of additional taxable income to avoid losing deductions or moving into a higher tax bracket. A qualified tax adviser can help you determine the correct amount to convert. Be sure to plan for the tax bill. In some cases you may need to make estimated tax payments or increase tax withholding to avoid an underpayment penalty.

The goal is to convert IRA assets while they are at depressed levels in order to maximize the amount of the conversion. Income tax rates are scheduled to move substantially higher in 2013 unless Congress acts by December 31, 2012. Moving assets to a tax-free Roth account while income tax rates are low could be a huge advantage for your long-term tax planning. For more information on balancing your tax free savings, see our May 2010 newsletter [pdf].

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