Roth IRA

Be on the Lookout for Roth IRA Conversion Opportunities

Be on the lookout for market declines and associated Roth IRA conversion opportunities. Multiple opportunities may play out in one year.

Was last week’s 5.7% decline in the Dow Jones Industrial Average (DJIA), from 11,009 on April 30th to 10,380 on May 7th, a temporary pullback from the recent highs this year or the beginning of a prolonged market decline? Unless your crystal ball works better than mine, we won’t know the answer to this question until several months or more from now when we’re looking in the rearview mirror.

While I don’t practice market timing for my clients, I believe that it’s prudent to look for opportunities to implement investment strategies to take advantage of various market conditions. Although a Roth IRA conversion will result in elimination of income tax liability on Roth IRA distributions provided no withdrawals are taken within five years of the conversion and the Roth IRA owner is at least 59-1/2 when taking distributions (see Year of the Conversion), this benefit can be negated by income tax liability associated with the conversion, itself.

When exploring a Roth IRA conversion, you want to look for opportunities to convert the greatest amount of your traditional IRA to a Roth IRA with the least amount of income tax liability. There are three things that directly affect the amount of income tax liability you will incur in connection with a Roth IRA conversion as follows:

  1. Income tax attributes
  2. Income tax rates, allowable deductions, and tax credits
  3. Investment valuation

Income tax attributes were addressed in the following three blog posts:

  1. The Ideal Roth IRA Conversion Candidate – Part 1
  2. The Ideal Roth IRA Conversion Candidate – Part 2
  3. Two Great Roth IRA Conversion Candidates

Although it can turn out otherwise, there is general consensus that the income tax rates, allowable deductions, and tax credits in effect in 2010 will probably be as good as it gets for a long time. With the scheduled 2011 3% – 5% income tax bracket increases (see In Which Tax Year(s) Should You Include Your 2010 Roth IRA Conversion Income? – Parts 1 and 2), it could be beneficial to make an election to report 100% of your Roth IRA conversion income on your 2010 income tax return vs. deferring and splitting the income between 2011 and 2012.

This leaves investment valuation. While we’re general unable to influence and control market prices, we’re able to choose when and how we want to participate in the market. Even though a Roth IRA conversion is generally a long-term strategy, if possible, you want to execute your conversions after market declines. To the extent that you’re considering a Roth IRA conversion, a 5+% market decline such as the one we recently experienced, combined with the fact that the DJIA is down 26.7% from its October 9, 2007 high of 14,165, may be an opportunity to do a partial or complete Roth IRA conversion.

Be on the lookout for market declines and associated Roth IRA conversion opportunities. As discussed in Roth IRA Conversion – A Multi-Year Strategy, a Roth IRA conversion doesn’t have to be, and in most cases shouldn’t be, a one-time event. Multiple opportunities may play out within one year or potentially over several years. If you’re wearing your Roth IRA conversion binoculars, you’ll spot them. If it turns out that the market declines further from the time of your conversion and you’re within the permissible timeframe, don’t forget about another investment strategy – recharacterization (see Recharacterization – Your Roth IRA Conversion Insurance Policy).

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.