Down Markets Might Be A Great Time for IRA Tax Strategies

The stock market’s roller-coaster performance in recent months may provide you with a tax planning opportunity.

Earnings from traditional IRAs or qualified retirement plans like 401(k) are tax deferred until withdrawn.  Roth IRAs on the other hand generally receive earnings on their investments tax-free.  Since there is a clear advantage of a Roth IRA, there are some tax strategies for converting assets to Roth IRAs that are worth looking at while markets are undervalued and tax rates are low.

Taxpayers may convert funds in traditional IRAs or qualified plans to Roth IRAs regardless of their income level.  Amounts in a SEP-IRA or a SIMPLE IRA also may be converted to a Roth IRA, but  only after the plan has been set up for a 2-year period.

Since assets are transferred to a Roth IRA at their current fair market value, a market decline gives you a chance to convert  to a Roth IRA at a much lower tax cost than would have been possible when stock market values were high.  Roth IRAs are generally deemed to be more tax advantageous since earnings are received tax free. It is important to remember that funds converted to a Roth IRA are subject to income tax either in the year converted or over the next two years. 

Since we will pay tax on the value of the assets transferred, we like this strategy when the assets transfered are significantly undervalued, but we think that over the long term they will be profitable investments.

A taxpayer who converts from a traditional IRA or qualified plan account invested in stocks to a Roth IRA when the market was higher will wind up with an artificially high tax bill. Fortunately, the taxpayer can treat the conversion as if it had never been made by recharacterizing it. This involves transferring the converted amount (plus earnings, or minus losses) from the Roth IRA to a traditional IRA via a direct, trustee-to-trustee transfer.

Since we have the ability to undue a Roth conversion, we recommend that you look very closely at your qualified plan assets to determine if there are any undervalued assets.  If so, it may be a good time to convert some assets to a Roth IRA.  You need to determine the immediate tax implications and consider if there is benefit from paying the tax currently in exchange of tax-free future earnings. 

We have seen a lot of success with “hard to value assets” such as partnership interests in commercial real estate activities like shopping centers.  Due to market conditions and modern valuation methods these assets usually have a lower than expected current fair market value. This type of investment in a traditional IRA or qualified plan is an ideal target for converting to a Roth IRA.

Regardless of your current retirement plan holdings it is a great time to review your holdings and decide if you should convert some assets to a Roth IRA.

If you need any assistance determining the tax implication for converting to a Roth IRA, please do not hesitate to contact us.

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