Finding the Silver Lining: Bear Market = Cheaper Roth Conversions
You’ve probably heard the old joke about the optimist who fell out of a tenth-story window. As he fell past an open fifth-story window, somebody heard him say, “So far, so good!”
At this point, nearly halfway through 2022, it’s pretty hard to be optimistic; the market feels like it fell out of a tenth-story window. But not everything about the current bearish market conditions is necessarily bad. That might be hard to believe, but think about it: Dozens of well-run companies that are financially sound are more attractively priced now than they have been in many months; as bond prices fall, yields are rising, which means that over the long haul, fixed-income investors can probably look forward to better income streams; many portfolios are benefitting from tax-loss harvesting, which bodes well for offsetting future capital gains and reducing the amount of checks written to the IRS.
And another benefit of the falling market is that taxpayers holding traditional 401(k) plan and IRA accounts now have an opportunity to convert to Roth accounts—jettisoning RMDs and securing tax-free income in retirement—at bargain prices. Because assets in traditional 401(k) accounts and IRAs represent pre-tax contributions, converting to a Roth account requires paying taxes on them now in order to gain tax-free status when funds are withdrawn in retirement. That means that the most advantageous time to make those conversions is while the taxpayer is in a lower bracket or the assets are at depressed prices—or preferably, both. Then, when the markets have resumed their upward trajectory (which they always have) and the taxpayer is potentially in a higher tax bracket, the balance in the account will look a lot healthier and, even better, if the owner takes retirement income from the account that income will not be subject to income tax.
It’s also worth keeping in mind that the current, relatively low income tax rates in effect as part of the Tax Cuts and Jobs Act of 2017 are scheduled to “sunset” in 2026 unless Congress acts to extend them. While there’s no way to predict what Congress will or won’t do, many taxpayers could be in a higher bracket in future years than they are now. That’s one more reason to consider a Roth conversion; it takes future income out of the taxable category.
The other benefit to a Roth IRA account is the absence of required minimum distributions (RMDs). With a traditional account, taxpayers must begin taking RMDs by age 72, which can sometimes thrust them into a higher tax bracket. But with a Roth IRA, there is no RMD requirement; account holders can leave the money in the account as long as they wish. Note that Roth 401(k) accounts do have RMDs, but many taxpayers can avoid them by rolling their Roth 401(k) account into a Roth IRA.
At Bernhardt Wealth Management, our core focus is on helping our clients make smart, tax-efficient decisions for their retirement and other important financial goals. To learn more, click here to read our recent article, “Making Lemonade: Tax-Loss Harvesting.”