Wealth managers see Roth conversions as bright side of market volatility

There’s no doubt that market volatility is unnerving for investors. And, yes, these wild market swings require a whole lot of handholding by advisors to soothe the fears of anxious clients.

But there is an upside to markets that collapse on a dime, or a tweet. An oversized drop in stocks could also signal the perfect occasion to take advantage of a Roth conversion.

Just don’t call it market timing.

“If a client converts when the market is down, the eventual recovery occurs within the tax-free Roth account. This matters because a Roth conversion creates an immediate tax liability in the year of the conversion,” said Chris Moring, senior wealth advisor at Quotient Wealth Partners.

“As a result, there is typically a breakeven point, which may not occur for several years, depending on the size of the conversion. Converting at a market low and capturing the recovery in a tax-free account can accelerate the time it takes to reach that breakeven point,” Moring said.

Often, what matters most is an individual’s or couple’s total income in a given calendar year, which may not be clear until late in the year, according to Moring. Unexpected income can push someone into a higher tax bracket, and a Roth conversion could compound that issue.

Age also plays a critical role, Moring said, as it affects factors such as Social Security eligibility, Medicare premium surcharges (IRMAA), and Required Minimum Distributions (RMDs), which begin at age 73 or 75, depending on the individual’s birth year.

Time to talk taxes

Helen Andreoli, managing partner at Great Diamond, highlights the fact that the conversion from a Traditional IRA to a Roth IRA is a taxable event, and the amount that is transferred from one’s Traditional IRA to a Roth IRA is taxed at ordinary income rates. The benefit, of course, is that the newly invested Roth IRA assets will grow tax deferred and be withdrawn in retirement with no tax implications.

In addition, she points out that Roth assets are not part of one’s Required Minimum Distribution (RMD) calculation, so one can let these assets grow over the course of a lifetime.

“If you don’t need these funds for retirement cash flow, they can provide a very nice inheritance for loved ones,” Andreoli said.

Timing, once again, is everything.

“If the market value has risen dramatically, your tax bill will be higher. There are several factors you need to consider in terms of timing. You also will have a tax bill associated with the conversion – make sure you have the funds available to pay for it!” Andreoli said.

Don't wait for it, plan for it

Since market drawdowns are inherently unpredictable, it’s not practical to wait for a specific decline, such as a 20% drop, to trigger a conversion, said Taylor Hart, president of Steadmont Advisors. That’s why market volatility rarely changes his overall recommendation on Roth conversions.

“Roth conversions should be approached from a comprehensive planning perspective. We evaluate whether there's both a need and an opportunity to convert, using financial planning software and collaborating closely with the client’s tax advisor,” Hart said.

It also should be done with professional guidance, ideally with the consultation of a client’s tax advisor.

And yes, timing does matter, admitted Hart, but not in the sense of trying to predict market downturns, which most wealth managers consider a fool’s game.

“Ideally, a Roth conversion occurs after a market pullback, when asset values are lower, so future growth happens tax-free within the Roth account,” Hart said. “The earlier you convert, the more time your money has to grow tax-free, which can greatly enhance long-term benefits.”