Attention all shoppers: Stay clear of the Roth IRA conversion aisle this Friday.
Two years ago I wrote and published an article, Black Friday – Think Roth IRA Conversion. At the time, the Dow Jones Industrial Average [DJIA] declined 1,000 points, or 8%, in two months, closing at 12,588 on November 16, 2012 after finishing at 13,593 on September 14, 2012.
That article couldn’t have been timelier. Beginning with the next market session on November 19, 2012, the DJIA has been on a tear, closing at a record high of 17,810 this past Friday.
The two-year increase of 5,200 points, or 41%, has proven to be a bonanza for Roth IRA account owners who did conversions in November, 2012. Those individuals have benefited in at least three different ways:
1. Elimination of income taxation on 100% of Roth IRA appreciation
Individuals who did a Roth IRA conversion in November, 2012 have eliminated taxation on 100% of sizable appreciation in the value of their Roth IRA in just two years. The amount of appreciation has already exceeded the amount of income tax liability attributable to the conversions in many cases.
Even with an inevitable stock market downturn, the opportunity for further appreciation and elimination of additional income tax liability remains a real possibility for most individuals who did Roth IRA conversions two years ago.
2. Roth IRA not subject to required minimum distribution rules
The opportunity to escape taxation on appreciation of Roth IRA assets continues for the duration of an original Roth IRA owner’s lifetime. Unlike traditional IRA owners who must take annual minimum withdrawals beginning by April 1 of the year following the year they turn 70-1/2, original Roth IRA owners aren’t subject to this rule.
Roth IRA beneficiaries may continue to extend the life of Roth IRA assets with one difference: they’re required to take annual minimum distributions beginning the year following the year of the original owner’s death.
3. Reduced exposure to required minimum distributions for remaining traditional IRAs
When you do a partial Roth IRA conversion, you reduce your exposure to required minimum distributions (RMDs) on any remaining traditional IRAs. Let’s assume you convert $200,000 of your traditional IRA with a value of $500,000 when you’re 50. Fast forward 20 years to age 70. Assuming a 60% increase in value, your Roth and traditional IRAs are now worth $320,000 and $480,000, respectively, for a total of $800,000.
Had you not done a partial Roth IRA conversion 20 years ago, you would own a traditional IRA with a value of $800,000. Your hypothetical first year RMD would be $29,197, or $11,679 greater than your actual RMD of $17,518.
Roth IRA conversions no longer on sale
While individuals who did Roth IRA conversions two years ago have realized, and continue to realize, the foregoing three benefits, current market conditions don’t favor new Roth IRA conversions.
Be patient Roth IRA conversion shoppers. Your time will come. Unless you have losses that you can use to offset the income you will realize from doing a Roth IRA conversion, this isn’t the time to be doing one. The risk/reward tradeoff, i.e., the amount of income tax you will pay in exchange for potential significant appreciation over a reasonable period isn’t worth it in my opinion.