Making Lemonade Out Of Lemons – The Power Of Roth IRA Conversions In A Down Market

“There are risks and costs to a program of action. But they are far less than the long-range risks and costs of comfortable inaction.” -John F. Kennedy

The COVID 19 coronavirus has triggered a stock market correction of historic proportions. In the week just past, the Dow Jones Industrial Average and Standard and Poor’s 500 Index fell by 12% and 11%, respectively. At the same time, the VIX volatility index (the “fear index”) soared to just under 50, the highest since 2011. By the time the dust settled, the U.S. stock market lost more than $3 trillion in value, its worst weekly performance since the Great Recession. 

The sudden spike in stock market volatility has led many individual investors to look for ways to de-risk their investment portfolios. The traditional way is to sell higher-risk assets (stocks) and reinvest the proceeds in lower-risk assets (bonds and cash).

There are significant drawbacks to the conventional approach to de-risking investment portfolios. They include the potential for a market to spring back and the triggering of capital-gain taxes. Numerous studies have demonstrated time and again that these drawbacks often outweigh the potential benefits of changing asset class allocations.

A Roth IRA conversion is an unconventional way to reduce the harm caused by a market correction. A Roth IRA is a special type of IRA that is funded with after-tax contributions. While contributions to a Roth IRA are taxable, distributions from a Roth IRA (whether to you or your designated beneficiary) are not. In other words, while tax on the earnings of a traditional IRA are deferred until those earnings are distributed, the income earned on a Roth IRA’s investments is never taxed.

An existing traditional IRA can be converted to a Roth IRA. Such a conversion can significantly boost retirement benefits if the value of the IRA’s investments appreciate more rapidly after the conversion occurs and/or income tax rates increase after the conversion occurs. Right now, there is good reason to believe both of these could occur, making it an ideal time to consider a Roth IRA conversion.

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