Here’s Why Roth IRA Conversions Can Work in a Bear Market

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Soaring inflation, rising interest rates and the war in Ukraine have caused constant volatility in the stock market. But there could be a bright spot: the opportunity to save money on Roth conversions.

This strategy allows people with higher incomes to skip income limit for Roth individual retirement account contributions, capped at $144,000 of adjusted adjusted gross income for single investors and $214,000 for couples filing together in 2022.

Here’s how it works: Investors make what are known as non-deductible contributions to a pre-tax IRA before converting funds to a Roth IRA, kicking off tax-free growth.

It’s almost like having that Roth IRA sold.

Ashton Lawrence

Partner at Goldfinch Wealth Management

The balance is that Roth conversions trigger an upfront tax bill on contributions and earnings. The larger your pre-tax balance, the more you owe for the conversion.

And the latest stock volatility could be an opportunity for investors to keep an eye on Roth’s transformation, said certified financial planner Ashton Lawrence, partner at Goldfinch Wealth Management in Greenville, South Carolina , said.

“It’s almost like having that Roth IRA sold,” he said.

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For example, say you have a traditional IRA worth $100,000, you like investments, and when the whole market goes down, the value drops to $65,000. You can save money by converting $65,000 instead of the original $100,000.

The major stock market average has fallen over the past five weeks, Tuesday morning soak after three days of heavy selling.

In the first quarter of 2022, Roth conversions were up 18% compared to the first quarter of 2021, according to data from Fidelity Investments.

Prepaid tax invoice

While a Roth conversion during a stock market drop may seem appealing, experts say the decision has to do with more than just asset value.

Marianela Collado, CFP and CPA of Plantation, Florida-based to Tobias Financial Advisors, says you need to consider how many years it will take to break even on a prepaid tax bill.

You’ll also need to consider the combined balances on IRA accounts, because of the so-called “proportional rule,” which factor in your pre-tax and after-tax totals to calculate your bill. .

Collado added: “It’s one of those things that you can’t see in a vacuum.

Five-year rule

Furthermore, while Roth IRAs typically offer no-times and tax-free withdrawals for contributions, there is a exception for conversion known as the “five-year rule”.

Investors must wait five years before they can withdraw their converted balance, regardless of their age, or they will incur a 10% penalty. The timeline begins on January 1 of the transition year.

Increase adjusted gross income

Another possible downside of a Roth transition is the potential for an increase in adjusted gross earnings for that year, which could cause other problems, Lawrence said.

Eg, Medicare Part NO calculate monthly premiums using modified adjusted gross income, known as MAGI, from two years ago, meaning that 2022 income could generate higher costs in 2024.

The base amount for Medicare Part B in 2022 is $170.10 per month, and payments will increase as your MAGI crosses $91,000 or $182,000 for joint filers.

For 2022, the top Medicare Part B surcharge is $578.30 when MAGI exceeds $500,000 for single applicants or $750,000 for couples filing together.

“It’s like a balloon,” Lawrence explained. “If you squeeze it at one end, you’ll inflate it somewhere else.”

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