Waiting on Your Roth Conversion Could Cost You

Too often, Roth conversions are relegated to a year-end tax task. The reality is that this approach can be costly, because it fails to take advantage of market volatility—particularly the dips and corrections that can create some of the most compelling conversion opportunities.

At a minimum, you should have a general range in mind now for how much you plan to convert over the course of the year.

Let’s take a step back: What is a Roth conversion?

A Roth conversion involves moving cash or investments in kind from a pre-tax account into a Roth IRA. The amount converted becomes taxable income in the year of the conversion, with taxes paid either through estimated payments or when you file your return the following April.

Roth conversions tend to work best when the tax bill is paid using non-retirement funds. This allows the entire converted balance to remain invested and benefit from tax-free growth going forward.

…and in what instances does it make sense to make a Roth conversion?

At its core, a Roth conversion works best in years when income is uncharacteristically low. Converting in a low-income year allows you to pay taxes on those dollars at a lower rate than you reasonably expect to face in the future.

Roth conversions can also be a powerful legacy planning tool. If you intend to leave retirement assets to your children—and they are likely to be in a higher tax bracket than you are—those dollars are often far more valuable to them as an after-tax asset rather than a pre-tax one.

Of course, there is meaningful analysis that goes into when to convert and how much to convert. Every situation is unique and deserves individualized discussion to determine an optimal strategy.

Tackling the tough questions.

Have you determined whether you are a candidate for a Roth conversion this year? If the answer is “I’m not sure,” now is the perfect time to analyze whether this is an option for you. If the answer is “Yes, I do a conversion nearly every year,” has a preliminary tax projection been run to determine the optimal conversion amount? Do you know the estimated federal and state tax impact of that conversion? If the answer to any of those questions is no, there is still work to be done, especially if you want to be prepared to take advantage of any down days in the market this year. While we generally don’t want to sell low, we do want to convert low whenever possible.

This material is intended for educational purposes only. You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. Nothing in this material constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Past performance does not guarantee future performance. Future returns may be lower or higher. Investments involve risk. Investment values will fluctuate with market conditions, and security positions, when sold, may be worth less or more than their original cost. Advisory Services offered through Avise Financial Cooperative Inc, a Registered Investment Adviser with the SEC. Registration of an investment adviser does not imply a certain level of skill or training.