The sharp decline in financial assets related to COVID19 has provided a potential incentive to convert all or just a portion of your Traditional IRA to a Roth IRA.  The conversion mechanics are easy.  You simply instruct the financial institution that holds your Traditional IRA to transfer funds to a Roth IRA.  If you don’t already have a Roth IRA, it is painless to set up. Instead of selling the securities and transferring the cash, you can transfer the securities directly to the Roth IRA.  An advantage of transferring securities rather than cash is that the assets are never uninvested.  The market is currently quite volatile and the lag between the sale and subsequent repurchase of assets is likely to cause trading costs and also could result in a random change in value of your assets, up or down.

Regardless of your age, removal of the assets from the Traditional IRA will not incur federal penalties if you transfer them to a Roth IRA.  However, the transfer of assets out of your Traditional IRA will likely generate ordinary income and you will likely pay federal and state income taxes.  While it is never enjoyable to pay taxes, if you expect your income tax rate to increase in the future then a Roth conversion may make sense for you.  It is better to pay taxes from a source of funds other than your IRAs.

All other factors being the same, a conversion seems to make more sense after a market decline.  If the market declines 25%, for example, then the taxes due from the transfer of an equity position from your Traditional IRA will also likely be lower.  That tax savings is permanent as the future withdrawals from the Roth IRA are generally nontaxable.

Forecasting future tax payments is very difficult.  Future tax payments depend on many factors including future federal and state tax rates and your personal income situation.  Often people expect taxable income to decline in retirement and some may expect tax rates to increase.  In addition, many people may expect to retire from states with high state tax rates to states with no tax rate.  Many states tax Traditional IRA withdrawals and yet others do not, even if they tax ordinary income.  In Illinois, for example, ordinary income is taxed by the state at 4.95% yet currently the state does not tax IRA withdrawals.  This state exemption could change in the future, however.  For example, during his campaign for governor, JB Pritzker discussed the idea of introducing a tax on IRA withdrawals.  Given the current and proposed federal and state expenditures related to the COVID19 pandemic, it is reasonable to forecast budget pressures will increase future federal and state tax rates. The net effect is a complex and very personal calculation.  Check with your advisors prior to making any decisions or taking actions.

A conversion of only a portion of an existing IRA may make the most sense.  Converting a larger amount may push you to a higher tax bracket or increase Part B Medicare payments if you happen to be enrolled in Medicare.  In addition, you will want to keep in mind you need to leave the converted assets in the Roth account for five years and be older than 59 1/2 in order for future Roth withdrawals to be withdrawn tax and penalty free.

Bottom line, if you have been contemplating a Roth conversion, the recent market decline just added one more reason to take action.

Notes:  The above article is the author’s sole opinion for information and discussion purposes only.  No part of this article is intended to constitute investment, legal or tax advice.  The opinions expressed herein are not suitable for all persons. Consult your investment, legal and tax professionals for advice relating to your personal situation.  No offer or solicitation is made by this article.  Past performance is not indicative of future results.