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Roth Conversion Opportunity?

Roth Conversion Opportunity?


Naturally, investors are disappointed with the poor start of the stock market for the first week of January after 2015 was nothing to celebrate about.  Rather than being upset, maybe a good response to the use the drop in value as an opportunity to start planned Roth conversions when the prices are lower.


As many IRA investors know, current tax law says no matter what your level of income a taxpayer can convert some or all of their IRA funds to a Roth if they are willing to pay the associated tax connected to the IRA.  This especially makes sense if the taxpayer remains in a lower tax bracket than they or their beneficiaries will be in the future or if they can stay within the same tax bracket and have the funds available to pay the tax.  If the rules of a Roth are followed the profits from the Roth will not be taxed.  An example is taxpayers who currently in a low tax bracket but will be in a higher tax bracket once required Minimum distribution (RMD) start when the taxpayer is over 70 ½.


Taxpayers over 70 ½ must remember that Roth conversions do not count as part of their Required Minimum Distribution (RMD).  Any Roth conversion would be in addition to the RMD for those over 70 ½.


If one will be in a lower tax bracket in retirement, Roth conversions do make sense.  Even yearly Roth contributions should be avoided if one has limited retirement assets such as IRA’s, pensions and Social Security.  Better to use the power of tax deferment with a 401kand/or IRA, in that case, to save for retirement. 

Of course, no taxpayer would like to pay tax on such a Roth conversion if the value of the investment drops significantly.  But the rules allow one to take back or re-characterize the conversion until October 15 of the following tax year.  Yes, this takes a little paperwork but is worth the effort.

Naturally some investments do well in a particular calendar year while other do not.  If one takes the effort to create several Roth conversions account for the year with a unique investment in each, then one can choose until that October 15 which one(s) if any, one is going to pull back or re-characterize back to the IRA account.  For example, if one wanted to max out the 15% tax bracket, one could pull back the exact amount one would need to hit the top of the tax bracket.  Stated differently, some conversions intentionally more than they project would be needed to fill the tax bracket.  The poor performing investments are used to fill the re-characterization. 

One can still do this if only one Roth conversion account was opened for the year.  But in that case then the overall gain performance of that one account is used to determine how much will be taxed.  With multiple conversion accounts one can pick and choose want will be moved back to the IRA.

This brings me back to the initial thought.  The stock market is down 6-7% for the first week of the year.  Rather than wait to do a 2016 Roth, why not select at least an initial amount to convert into a new Roth account. I personally would set this at about 25% of what one will convert to a Roth for the year.   If the market ends, for example, breaking even for the year, you will have profited by paying tax on a lower amount.  If the market continue to decline, the re-characterization is available.  Even If the market ends up having a good year we will have done very well paying tax on a lower amount.

Then the possibility exists with each other market ‘correction’ during 2016 we move another amount until our desired total conversion value is reached. .  If the selected investment for each account are less correlated to each other than the possibility of some doing better than others is increased ideally using a different account each time to keep each movement uniquely identified.

In short, the above described moves would be a possible way to use the bad, hopefully short term news, to our advantage.

Of course, I like everyone else does not know what moves the market will make for the remainder of 2016.

If you seek more information do not hesitate to contact Ednomics.