The saying goes, “Every dark cloud has a silver lining.” The current dark cloud over the stock market is no different. As we experience the thunderous downpour of this bear market with returns down approximately 20%, there are silver linings (or opportunities) that you can take advantage of. The downturn may mean it’s a good time for a Roth IRA conversion, bolstering your long-term plan for financial independence.

Often, investors overreact in a down market such as this one and may make emotional investment decisions, feeling they must make a move within their portfolio. Most of the time, during short-term volatility, making a move for the sake of making a move is the wrong decision. But two great opportunities present themselves in the current market environment.

Opportunity #1: Tax-Loss Harvesting

One opportunity is tax-loss selling (also known as tax-loss harvesting), a tax planning strategy used to help investors reduce their capital gains tax liability by selling holdings in non-retirement accounts with a loss. The sales proceeds are then reinvested in the market at the current value, setting a new, lower-cost basis for future sales. The losses generated can be used to offset future capital gains.

Please read our article, “Now may be the Right Time for Tax-Loss Selling,” for further details.

Opportunity #2: Roth IRA Conversion

The second opportunity presenting itself during this storm is the Roth IRA Conversion. A Roth IRA Conversion is when you transfer funds from your pre-tax Traditional IRA into a Roth IRA and pay tax on the amount you convert at your ordinary income tax rate. The benefit to this move is that the funds will grow tax-free if held for more than five years and upon reaching age 59 ½. An additional benefit to the Roth IRA is that, unlike the Traditional IRA, you are not required to take a minimum distribution from the Roth IRA starting at age 72.

To learn more about the benefits of Roth IRA conversions, please read our article “2021 Year-end Tax Planning Strategies.”

Many investors consider making Roth IRA conversions towards the end of the calendar year as part of income tax planning. However, the current downturn in the stock market presents an opportunity to make Roth IRA conversions now. This is because the goal for funds in a Roth IRA is to try to maximize the growth in the account since there will be no tax on any distributions during your lifetime. By converting funds now, while the stock market is down approximately 20%, you will be transferring the future gains from the inevitable stock market recovery from the Traditional IRA to the tax-free Roth IRA.

How a Roth IRA Conversion Can Benefit You

Here is an example of how making a Roth IRA conversion before the market recovery can benefit you.

The Scenario:
On January 1, 2022, you have a Traditional IRA valued at $100,000.
After the 20% market decrease, the current value is $80,000.
The stock market recovers the entire loss by December 31, 2022, and your IRA is back to being worth $100,000.

If you had chosen to wait until December 31, 2022, to convert the entire balance of the IRA to the Roth IRA, you would incur taxes of $30,000 (assuming a 30% income tax rate).

If you convert the entire amount now when the market is down 20%, you will incur taxes of $24,000.

The timing of the maneuver saves you $6,000 in taxes. The added benefit to doing it now is that as the stock market recovers, the investments in the Roth IRA will also increase, shifting more of the increase to the investments in the Roth IRA.

The Bottom Line

We understand this is a very uncomfortable time for investors. But there are opportunities to consider that can help position your investment portfolio to more tax efficiently grow when the market recovers over the next few years.

As we recommend with all strategies, before moving forward with a Roth IRA conversion, you should review your situation with your financial planner to ensure it makes sense for your specific situation.