Market downturns are uncomfortable. No one enjoys seeing account values fall, and it is natural to focus on the short-term damage.
But a difficult market can also create planning opportunities. One of the most important is the Roth conversion.
A Roth conversion means moving money from a traditional IRA into a Roth IRA. You pay taxes on the converted amount today, and in exchange, the money has the potential to grow and be withdrawn tax-free in the future, assuming Roth distribution rules are met. Roth IRAs also do not require lifetime required minimum distributions for the original account owner, which can create more flexibility later in retirement.
So where does a market downturn come in?
Because the tax cost of a Roth conversion is based on the value of the assets when they are converted. If an investment inside a traditional IRA has declined in value, converting that asset while it is down may allow you to move it into a Roth IRA at a lower taxable value.
For example, imagine an investment in a traditional IRA was worth $100,000 when purchased, but is now worth $75,000 after a market decline. If you convert that investment now, the taxable conversion amount is based on the current value, not what you originally paid for it. That makes the conversion more tax-efficient, and if that investment later recovers inside the Roth IRA, more of the rebound may occur in the tax-free bucket.
That is the opportunity.
It is not tax-loss harvesting. Selling a losing investment inside an IRA generally does not create a deductible capital loss, because gains and losses inside the IRA are not taxed each year the way they are in a taxable brokerage account. The benefit is not that the loss offsets other gains. The benefit is that a lower account value may reduce the tax cost of moving assets from a tax-deferred account into a tax-free one.
This can be especially useful for investors who already planned to consider Roth conversions as part of their retirement tax strategy.
The decision is not simply, “Will my tax rate be higher in the future?” It also depends on factors like current tax rate, future expected tax rate, time horizon, IRA basis, and whether conversion taxes can be paid from outside assets.
Still, a down market does not automatically make a Roth conversion the right move.
A Roth conversion creates taxable income in the year of conversion. That income can affect more than your ordinary tax bracket. For retirees, it may also influence the taxation of Social Security benefits, Medicare IRMAA surcharges, and other income-sensitive planning thresholds.
That is why Roth conversions should be evaluated carefully, not rushed. The goal is not to convert just because the market is down. The goal is to determine whether today’s lower values create a better long-term tax planning opportunity.
A market decline may be a good time to ask:
- Do I have traditional IRA assets that may be good candidates for conversion?
- Am I currently in a reasonable tax bracket?
- Can I pay the conversion taxes from cash or taxable assets outside the IRA?
- Do I have enough time for the Roth assets to benefit from future tax-free growth?
- Could a conversion help reduce future required minimum distributions?
- Would the conversion create unwanted tax consequences this year?
Market volatility can make investors feel like they have no control. But tax planning is one area where thoughtful action may still be possible.
A Roth conversion during a downturn is not about predicting the market bottom. It is about recognizing that lower asset values can sometimes create a more favorable window for long-term planning.
If you want to explore whether a Roth conversion fits your retirement and tax strategy, contact your Hanover representative. The goal is not to guess where markets go next. The goal is to use the opportunities available today to build a more flexible plan for tomorrow.