Market window of opportunity
By Robert Klein, CPA
As I write this article, the S&P 500 has lost 917 points, or 19%, in less than four and a half months, falling from its high of 4,819 on January 4 to a low of 3,901 on May 20 before close at 4,158 on May 27. The NASDAQ fell 5,085 points, or 31.5%, from its high of 16,121 on November 19, 2021 to a low of 11,036 on May 20 before closing at 12,131 on May 27.
A bear market occurs when an index has fallen 20% or more from a recent high for an extended period. The NASDAQ has been in a bear market, with the S&P 500 on the brink.
Staged Roth IRA Conversion Opportunity Window
In my role as a retirement income planner, I am always looking for windows of opportunity for my clients to leverage and protect their assets to maximize their projected after-tax retirement income. One such window of opportunity that has proven to be a successful part of many of my clients’ retirement income plans is the use of a staged Roth IRA conversion plan during market downturns, especially in bear markets.
A Roth IRA Staged Conversion Plan is a multi-year strategic plan used to optimize the projected longevity of its assets as part of a holistic retirement income plan. The purpose of using a multi-year approach is to minimize the income tax associated with Roth IRA conversions while taking advantage of market downturns whenever possible. Low federal income tax rates that are due to expire after 2025 and could occur sooner provide the opportunity to minimize income tax on Roth IRA conversions.
Eliminate taxation on the growth of converted assets
The main purpose of a Roth IRA conversion is to eliminate taxation on the growth of converted assets. Although Roth IRA conversions result in taxation of the value of the converted amounts to the extent they exceed base, 100% of the value of Roth IRA assets, including appreciation, is tax-exempt. Appreciation is generally responsible for the majority of the value of pension plan assets over time.
For example, suppose you made a Roth IRA conversion of $100,000 into an S&P 500 index on March 23, 2020 when the index closed at 2,237. This was the bottom of the last S&P 500 bear market, when the index fell 34% in the one-month period that started on February 19, 2020.
Let’s move quickly. Even though the S&P 500 has fallen 14% from its high of 4,819 on January 4 to its May 27 close of 4,158, it has appreciated 1,921 points, or 86%, since you made your hypothetical Roth IRA conversion on March 23, 2020. Your Roth IRA would currently be worth $186,000 with an unrealized capital gain of $86,000 permanently tax-free.
Why implement a step-by-step Roth IRA conversion plan?
The motivation for implementing a step-by-step Roth IRA conversion plan is simple. If you invest in taxable retirement plans such as traditional 401(k), SEP-IRAand traditional IRAs, the good news is that you get a tax deduction for your contributions and your assets grow tax-deferred as long as they remain in your various plans.
The bad news is that 100% of the contributions you make to your plan and the appreciation will be subject to tax from the time you start receiving distributions until all assets have been withdrawn from your plans. by you, your spouse and possibly other beneficiaries. Again, appreciation is generally responsible for the majority of the value of pension plan assets over time.
If you do not make strategic Roth IRA conversions, the amount of income tax attributable to your distributions may exceed the tax liability you would incur under a staged Roth IRA conversion plan. This translates into less disposable income during your retirement years and a potential depletion of investment assets sooner than would otherwise occur. The likelihood of this happening increases to the extent that you are not reinvesting income tax savings from deductible contributions into your traditional 401(k), SEP-IRA, or traditional IRA, which is often the case.
Other Benefits of a Step-by-Step Roth IRA Conversion Plan
In addition to permanently eliminating taxation on the growth of converted assets, a staged Roth IRA conversion plan offers the following five benefits which are discussed in 7 reasons to start a step-by-step Roth IRA conversion plan today and 6 proven retirement income planning strategies starting at age 62:
- Reduce required minimum distributions from age 72
- Potentially reduce Medicare Part B and D premiums
- Reduce widow’s or widower’s income tax
- Reduce dependence on taxable assets in retirement
- Reduce the taxable income of non-spouse beneficiaries
Each of the above benefits can individually and collectively extend the life of after-tax assets for their owners and beneficiaries.
Should you wait for the stock market to drop more to do a step-by-step Roth IRA conversion plan?
Although the S&P 500 and NASDAQ are down about 20% and 30%, respectively, from their recent highs, a common question is, “Do I have to wait longer to make a Roth IRA conversion since the stock market could drop further?
One of the benefits of a staged Roth IRA conversion plan is that Roth IRA conversions happen in stages at convenient times. A 15% to 20% drop in the value of a retirement plan is an opportune time to make a Roth IRA conversion.
The goal should never be to try to time the market. The nature of a staged Roth IRA conversion is such that you can make multiple Roth IRA conversions in a given year if the value of your taxable retirement plan declines after your initial conversion.
The Current Roth IRA Conversion Window of Opportunity Won’t Last Forever
A market downturn, especially a bear market, is always painful when you go through it. Like any storm, however, it won’t last forever. This was demonstrated in the example where the S&P 500 index fell 34% in one month from February 19, 2020 due to the COVID-19 pandemic, after which global stock markets returned to a bull market in April 2020.
Because Roth IRA staggered conversion plans are proven to extend the life of after-tax retirement plan income and assets in many cases, low federal tax rates are expected to expire after 2025 and could happen sooner, and it’s generally prudent to spread Roth IRA conversions over multiple years, the current Roth IRA conversion window of opportunity should be on the radar of every taxable retirement plan participant or owner.
If you’re in your 40s, 50s, or 60s and have traditional 401(k) plans, SEP-IRAs, and traditional IRAs, why wait until age 72 when the value of your plans has potentially doubled or tripled and that tax rates are likely to be higher to start paying taxes on inflated distributions? Wouldn’t you rather use prudent tax-conscious retirement income planning strategies today to pay less tax for the rest of your life and have more funds available when you have the most? need, that is, during your retirement years?
About the Author – Robert Klein
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. The firm’s motto is Plan, manage and protect your retirement income™. Bob is the creator of FINANCIALLY InKLEIN’d™, a YouTube channel showcasing innovative tax-informed strategies to maximize retirement income. Bob is also the author and editor of Retirement Income Visions™a blog featuring innovative strategies for creating and optimizing retirement income that Bob started in 2009.
Bob applies his unique background, experience, expertise and specialization in tax-sensitive retirement income planning strategies, including fixed income annuities, Roth IRA conversions, HECM reverse mortgages and residual trusts charities, to optimize the projected longevity of its clients. income tax and pension assets. Bob does this as an independent financial advisor using personalized holistic planning solutions determined by each client’s financial needs.