Is Now the Right Time for a Roth IRA Conversion?

By Christopher L. Hudson, CIMA

With the S&P 500 Index down over 20% for the year, is there a possible silver lining in converting traditional IRA money into a Roth IRA in 2022?

A Roth IRA account allows retirement funds to grow tax deferred as well as offering tax-free withdrawals in retirement as long as the recipient is 59 ½ and the funds have been in the Roth IRA for at least 5 years from the first deposit / conversion. Roth IRA accounts are funded with after-tax dollars (unlike a company retirement plan or 410(K) which is typically funded with pre-tax contributions).

The process of converting traditional retirement funds (inside of an IRA account) to a Roth IRA is known as a “Roth IRA Conversion”. As part of this process, the investor will owe taxes on the balance that is being converted in the calendar year of the conversion. In other words, the amount being converted will be considered as ordinary income and will be added to any other income earned for the year. With the markets down significantly for the year, could this be an opportunity to convert some of your IRA funds into a Roth IRA account?

Let’s look at a simple example: Let’s say that a 50 year old investor has an IRA account that was valued at $200,000 at the end of 2021. The value of that IRA account is now $100,000 due to market volatility. Let’s also assume this investor is in the 32% tax bracket.

• A Roth conversion at the end of 2021 would have resulted in federal taxes due of $64,000 ($200,000 x 0.32).
• A Roth conversion in 2022 would result in federal taxes due of $32,000 ($100,000 x 0.32).
• Keep in mind that if this individual is still working (or receiving other earned and/or ordinary income) this conversion amount will be added to that income for purposes of taxes.

Why would an investor consider paying the tax bill upfront? Because as mentioned earlier, a Roth IRA not only allows your money to grow tax free but also allows tax free withdrawals. If that Roth IRA eventually grows to $500,000, and the owner takes a 5% withdrawal each year, that is $25,000/yr. in tax free income in retirement and could act as a very nice supplement to any taxable income they are receiving (pension income, Social Security, IRA / Qualified plan withdrawals, etc…).

As with any financial consideration, a Roth IRA conversion in 2022 is not necessarily right for every investor. But with the markets lower, interest rates and inflation higher and continued volatility, it could be a way to take advantage of the current market environment.

Any opinions are those of Christopher Hudson and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Asset allocation and diversification do not guarantee a profit nor protect against a loss. Raymond James and its advisors do not offer tax or legal advice. You should discuss tax or legal matters with the appropriate professional.