Whether you are still working or you are enjoying retirement, a declining market is a good time for traditional IRA owners to manage their IRA and consider tax saving strategies.  Overall income tax savings can be achieved by converting your traditional IRA to a Roth IRA when market conditions are favorable to do so.

Regardless of income level or filing status, owners of traditional IRA’s have two options available for conversion to a Roth:

  1. Rollover – this can be done by taking a distribution from your traditional IRA and rolling it into a Roth IRA within 60 days of the distribution.
  2. Trustee-to-trustee transfer – money is transferred from the trustee of the traditional IRA to the trustee of a Roth IRA.

Avoid Early Distribution Tax

Keep in mind that although Roth conversions avoid the 10% premature withdrawal penalty, they are not income tax free. A rollover from a traditional IRA to a Roth IRA will increase your taxable income for the year and will be taxed at your individual income tax rates.  However, in a declining stock market there is a silver lining!

A depressed market allows for taxpayers to make the rollover at a lower tax cost than would be possible if market values were higher. If you plan on remaining in the market long-term, it may be advantageous to transfer low-valued stocks or mutual funds to a Roth and pay tax now at a lower value, versus paying higher taxes down the road when the market recovers and distributions are commenced. Additionally, converting now starts the clock running on the 5-year period.  After 5 years, distributions can be taken from the Roth, even before age 59-1/2, without being subject to the 10% premature withdrawal penalty.

Converted When the Market was High?

If you converted your traditional IRA to a Roth IRA in the current year when market values were high, you will be needlessly paying a greater amount of tax on the amount converted. Consider that the IRS allows you to “re-characterize” that conversion by the extended due date of your tax return. It is thus treated as if the original conversion never happened, so you avoid paying any taxes at all. Then, if you wanted to take advantage of the depressed market at that time, you can still reconvert the traditional IRA to a Roth at any time.

As always, each taxpayer’s situation should be individually assessed to determine the most advantageous strategy based on timing and implications related to the taxpayer’s income level.  Please contact the Chortek Tax Team to discuss tax planning strategies.

Written by Patrick Wirth, CPA, CVA | Partner
Posted in Business Advisory, Tax