Why Now Is the Perfect Time to Do a Roth Conversion with David McKnight

The coronavirus downturn in the market is actually the perfect time to do a Roth Conversion because of the double sale that’s going on.

The first sale involves the next six years where we get to enjoy the lowest tax rates we are likely to see in our lifetimes. The second sale is due to the 35% drop in the stock market, your assets are now at much lower values and that means the tax on a potential Roth Conversion is also 35% lower.

If you were to hypothetically convert a $1 million IRA this year your tax bill would be approximately $299,112 or a 29% effective tax rate. If you take in the decline in the stock market of 35% your tax bill is a little more than half.

If the stock market goes through a massive recovery over the next few years having done this Roth Conversion, all of that recovery occurs in your tax-free bucket.

If the market is down 25%, your portfolio has to recover 33% to get back to where you started. If the market drops 50%, you need a 100% recovery to get back to even. Where would you prefer to have that recovery occur, in your tax-deferred bucket or your tax-free?

You have the opportunity to take advantage of a double tax sale right now. Your assets are 35% lower than they were about a month ago and that means the cost of getting into the tax-free bucket is on sale right now as well.

There are a couple of caveats to be aware of. If you decide to undertake a Roth Conversion right now and don’t have the tax withheld by your custodian, you don’t want to delay paying the tax because you will end up paying penalties and fees.

No matter your age, the very best place to pay for the taxes of a Roth Conversion is out of your taxable bucket. If you have more than six months worth of expenses in your taxable bucket you have some inherent tax inefficiencies in your portfolio that can cost you hundreds of thousands of dollars over your lifetime. Let’s use our least efficient bucket to help move money into our most efficient bucket.

When you contribute to a Roth IRA you have to use cash. That can be problematic because there can be lots of movement in the market when you liquify parts of your portfolio. You can’t predict what is going to happen with the market which is why the Roth conversion is so useful.

The Roth Conversion allows you to do a like-kind transfer where you can transfer shares you own from one account to a Roth IRA. This insulates you from the rise and fall of prices while you cash out from the market.

If you want to get into the zero percent tax bracket, you have a huge opportunity right now. The market will likely recover at some point in the future, and that means there are a number of great deals to be had right now. Ideally, your assets will be able to recover in the tax-free bucket and there is a big opportunity to do so in this market downturn.