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Investing Tip of the Day

* When converting from a taxable IRA/401k to a Roth IRA, it’s better to do it when the market is down.

The Roth IRA is perhaps the best tax-saving account type in America. The most notable of its many advantages is that your earnings accumulate tax-free and aren’t taxed when you withdraw. Traditional retirement account earnings also accumulate tax-free, but you must pay income taxes when you withdraw.

So, to see how a market downturn creates a good opportunity to convert to Roth, let’s look at an example. Assume you have $50,000 right now in a 401k. A year later, it drops to $40,000. A year after that, it pops back up to $60,000. Here’s how much you’d pay in income tax with a conversion in each of the years:

If you were smart enough to convert to Roth at the end of year 1, you pay only $8000. The additional $20,000 earned by your portfolio between years 1 and 2 is untaxed in the Roth, saving you $4000. This is, of course, a simplified example, as you need to consider other income and your unique financial situation. Plus, timing market downturns is difficult. Talk to a financial advisor for specific advice.

Keep this tip in mind though if, for example, stocks plummet after your government starts a major war or funds gain-of-function research that triggers a worldwide pandemic.

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