This Friday is Black Friday. It’s the day after Thanksgiving when major retailers open early promoting significant price reductions on lots of items. It has routinely been the busiest shopping day of the year since 2005.
There’s another major sale taking place as I write this post that’s not being publicized. It’s happening in the investment world. It’s one of those perfect storm moments when a confluence of seemingly unrelated factors occurs that results in a short-lived opportunity for those who act on it.
With the recent 1,000 point, or 8%, drop in the Dow Jones Industrial Average (DJIA), closing at 13,593 on September 14th and finishing at 12,588 on Friday, combined with a distinct possibility of higher income tax rates in 2013, with one notable exception, this is one of those moments for individuals considering a Roth IRA conversion.
Let’s start with the exception which is the result of the last major Roth IRA conversion opportunity. In 2010, individuals who did Roth IRA conversions were given the choice of including income from their conversion on their 2010 income tax returns or deferring it. If they chose the latter, they were required to report 50% of the income on their 2011 income tax returns and 50% on their 2012 returns.
Several of my clients did sizeable conversions in 2010, choosing to defer 50% of their Roth IRA conversion income to 2011 and 50% to 2012. While these individuals have enjoyed 30% increases in the equity portion of their Roth IRA accounts since 2010 as a result of the increase in the DJIA from the 10,000 level that will never be taxed, they will also be including large amounts of income from their 2010 conversions on their 2012 income tax returns. Without offsetting losses or deductions, most of these individuals won’t be good candidates for a 2012 Roth IRA conversion.
If your 2012 taxable income is being inflated by a large amount of deferred income from a 2010 Roth IRA conversion without offsetting losses or deductions, you may not be a good candidate for a 2012 Roth IRA conversion. Assuming that you don’t fall under this exception and you haven’t already done a sizeable Roth IRA conversion in 2012, you should be evaluating this strategy as part of your 2012 year-end income tax planning. Once again, there isn’t one, but two, events that make this a potentially timely transaction depending upon your tax situation, either one of which qualifies as a potential trigger.
While it’s possible that the stock market may decline further and income tax rates may not increase in 2013, the recent significant stock market decline in and of itself presents a Roth IRA conversion opportunity. In addition to avoiding taxation on future appreciation of conversion amounts, Roth IRA conversions result in reduction of taxable IRA accounts which in turn offers two other potential benefits.
Smaller taxable IRA accounts translate to smaller required minimum distributions (“RMD’s”) and reduced taxable income beginning at age 70-1/2. In addition, to the extent that you have less taxable income, you may be able to reduce the amount of your taxable Social Security benefits, providing for a second tax reduction opportunity as well as enhanced retirement income longevity.
While you’re setting your alarm clock to take advantage of all of those Black Friday sales, don’t forget about the Roth IRA conversion sale. It may be one of those short-lived investment opportunities that you won’t see for a long time.
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.