This year’s stock market volatility can
be unnerving, but if you have a traditional IRA, this volatility may provide a
valuable opportunity: It can allow you to convert your traditional IRA to a
Roth IRA at a lower tax cost.
Traditional IRAs
Contributions to a traditional IRA may
be deductible, depending on your modified adjusted gross income (MAGI) and
whether you participate in a qualified retirement plan, such as a 401(k). Funds
in the account can grow tax-deferred.
On the downside, you generally must pay
income tax on withdrawals, and, with only a few exceptions, you’ll face a
penalty if you withdraw funds before age 59½ — and an even larger penalty if
you don’t take your required minimum distributions (RMDs) after age 70½.
Roth IRAs
Roth IRA contributions, on the other
hand, are never deductible. But withdrawals — including earnings — are tax-free
as long as you’re age 59½ or older and the account has been open at least five
years.
In addition, you’re allowed to withdraw contributions at any time tax- and
penalty-free.
There are also estate planning
advantages to a Roth IRA. No RMD rules apply, so you can leave funds growing
tax-free for as long as you wish. Then distributions to whoever inherits your
Roth IRA will be income-tax-free as well.
The ability to contribute to a Roth IRA,
however, is subject to limits based on your MAGI. Fortunately, anyone is
eligible to convert a traditional IRA to a Roth. The catch? You’ll have to pay
income tax on the amount you convert.
Saving tax
This is where the “benefit” of stock
market volatility comes in. If your traditional IRA has lost value, converting
to a Roth now rather than later will minimize your tax hit. Plus, you’ll avoid
tax on future appreciation when the market stabilizes.
Of course, there are more ins and outs
of IRAs that need to be considered before executing a Roth IRA conversion. If
your interest is piqued, discuss with us whether a conversion is right for you.
