Top of Mind


Is Now the Time for a Roth Conversion?

Allowed by some retirement plans, a Roth conversion permits the transfer of pre-tax dollars to Roth, with income taxes paid on the transferred amount, instead of upon the distribution of the pre-tax funds. (once certain qualifications are met, Roth balances are not taxed at all upon distribution).

A number of recent articles, including this one, have commented that there has never been a better time to complete this conversion. Is this true? Let’s consider some of the reasons why this transaction is being touted:

  • Individuals will pay less tax on the money than they would have previously (say, in 2019), since retirement account balances have been lowered by the COVID-19 pandemic. — I don’t believe that this is a terribly strong argument for a 2020 Roth conversion, since it hinges on timing the market, which many people have tried—and failed—to do, for a reason. Of course, individuals will pay less tax on account balances that have been depressed by the market, but it is difficult to determine whether or not there is less money in the account now than there would have been on the exact day that a participant may have decided to complete a Roth conversion in, say, 2019? And what if the market drops again after the conversion is competed? There are stronger arguments for a Roth conversion, including the following.
  • Individuals may find themselves in a lower tax bracket for 2020 than they have been historically. — Those who have been laid off, faced salary reductions, or have otherwise been negatively impacted from a financial perspective might pay less tax on their Roth conversion, since, with less income, they are in a lower income tax bracket (even with the conversion amount) than normal. Of course, this only works if an individual can AFFORD to pay the 2020 taxes on the Roth conversion, and if he/she has suffered financially, that might not be the case. Fortunately, however, there might be additional tax relief available, as described below.
  • Individuals can spread out the tax liability if they are affected by COVID-19. — Those who have been laid off as a result of the COVID-19 pandemic, or have another qualifying reason under the CARES Act, can spread their tax bill for a 2020 Roth Conversion over a three-year period (2020, 2021 and 2022). This is an unlikely tax break in future years, so this may be the most compelling reason to complete a Roth conversion in 2020. But, again, this is only applicable to those affected by COVID-19, as defined under the CARES Act - and for those individuals who find themselves financially devastated by the pandemic, spreading the taxes out over three years may not help.
  • Tax brackets, in general, are at historic lows. — Another strong argument for a Roth conversion in 2020 is the historically low tax brackets; those who pay taxes now, when they are lower, will benefit if income tax rates go back up. And, with a sub-12% income tax rate on the first $80,000 of income for married couples filing jointly, it is hard to argue that tax rates will ever be lower, especially given the record government spending as the result of the pandemic. But hey, if I could truly predict future tax rates, or anything else about the future, I probably wouldn’t be writing this right now!

So, there you have it. The verdict? Converting at least some retirement assets to Roth has always been a prudent strategy, since it provides tax diversification. Individuals with both pre-tax and Roth retirement assets have some protection if they find themselves in a high-tax or low-tax environment at retirement. Thus, 2020 may be a good time for a Roth conversion, particularly for those who can afford to pay the taxes in light of the COVID-19 pandemic.

However, rather than converting a large amount of one’s account balance to Roth at any one time, which is then subject to the vagaries of market performance (assuming assets are not entirely in stable value investments), perhaps transferring smaller amounts in regular intervals, over a period of time, makes more sense. In this scenario, participants take the same advantage of dollar-cost-averaging principles, as they do with retirement plan contributions.

Do you have any other thoughts on Roth conversions? Feel free to let me know on LinkedIn, Twitter or at info@cammackretirement.com.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

Investment products available through Cammack LaRhette Brokerage, Inc.
Investment advisory services available through Cammack LaRhette Advisors, LLC.
Both located at 100 William Street, Suite 215, Wellesley, MA 02481 | p 781-237-2291