We are officially dealing with a stock market that has crossed into bear market territory — typically, when stocks or equity markets are down at least 20% from recent peaks — as the S&P 500 tumbled more than 20% from its all-time high on January 3.
While bear markets should never be celebrated, investors looking at longer-term horizons should use any opportunity available to help soften the blow on stock values during this current market downturn. One adjustment that can be made to potentially save a worried investor a lot of money in the future is to convert traditional individual retirement accounts (IRAs) to Roth IRAs. In fact, this is one strategy that is better done when the stock market and its prospects are at their most negative.
As Money explained, traditional IRAs are funded with pre-tax dollars while Roth IRAs contain post-tax money. When you fund a Roth with after-tax dollars — the money you withdraw after age 59 1/2 — those withdrawals are tax-free. The benefit of converting to a Roth IRA when the traditional IRA value is low is that the future appreciation and income of the IRA will be tax-free.
So, taking advantage of downturns in the market that lower your assets or income can end up saving you a lot of money in taxes. With the bear market devaluing all equity, it’s consequently pushing investors into lower tax brackets, and cutting their tax burden.
Speaking to Money, CEO of investment advisory firm The Wealth Alliance Robert Conzo said, “Markets are down and values of portfolios are down, so if you did the conversion and had to pay taxes, you’d pay a lesser amount because the value of your traditional IRA is lower.” He added, “If you had $200,000 in a traditional IRA that’s now worth $150,000, you’re going to be paying a lot less tax.”
Besides the pre- and post-tax funding differences between traditional and Roth IRAs, Merriman suggested Roth conversions can be a useful tax dodge almost every year, not just during those wherein markets struggled or featured bear markets.
Money noted other advantages to Roths IRAs, as well, such as their lack of required minimum distributions (all Roth withdrawals are voluntary) and all future asset growth in the Roth is treated as post-tax. So, all dividends, interest and earnings in the Roth are sheltered from taxes.
Additionally, by keeping your IRA and using it along with your Roth as a “Asset Location” approach, an investor can regard both accounts as one liquid one, moving funds to either account type depending on the best IRA match and tax advantage.
Per Money, there is one warning about IRA-to-Roth conversions: You are obligated to pay income tax on the funds you convert from one IRA to the other. So, you’ll need the funds to pay for that either in a lump sum or in intervals, as you do partial conversions.
Bear markets are scary, but they don’t last forever. They are usually followed by market upturns, even by extended bull markets. Ups and downs are part of your financial life, navigating them wisely and calmly is crucial to keep your money in good standing.
More From GOBankingRates