Why You Should Consider Converting Your IRA
If the market is down, you might be doing your future self a favor by converting all or some of your Traditional IRA into a Roth IRA.
Generally, when you convert a Traditional IRA, you’re taxed on the amount you convert. If your income is lower this year due to the economy, your tax rate might be lower too.
If the balance of your IRA has significantly dropped, then you may be able to convert more of your holdings at a lower price, potentially reducing the tax impact of your conversion.
Growth from a future market recovery is better in a Roth IRA because your future withdrawals won’t be taxed.
With great market volatility comes great opportunity. Drops in global markets can be stressful for many reasons, but they also provide opportunities to put yourself in a better financial position for the future.
Our investing advice of doing nothing and staying the course is generally the direction we try to nudge you towards when markets are down. However, performing external account transfers and performing Roth conversions are two actions you may want to consider taking when markets are volatile.
What is a Roth conversion?
When you contribute to a Traditional IRA, you generally are able to deduct your contributions to avoid paying taxes now. Eventually, when you withdraw money out of your Traditional IRA, the amount you withdraw is considered taxable income.
Comparatively, when you make deposits or conversions into your Roth IRA, you are using money that has already been taxed or will be taxed that year. Once money is in your Roth IRA, the contributions and any associated earnings will grow over time and withdrawals in retirement will be tax-free.
From a tax perspective, putting as much money into your Roth IRA as possible, at a tax rate that’s as low as possible, is one of the best strategies you can use to make the most of your money.
There are no income limits for converting to a Roth IRA, and you can perform as many Roth conversions as you want. It’s important to know that once you perform a conversion, you can’t undo it. Before you convert, it might be helpful to be aware of some of the common mistakes people make when performing Roth conversions.
Here are a few reasons why you may want to convert your IRA when the market is down.
Your income might be lower this year. If you or your spouse have been laid off, furloughed, or your working hours have been reduced, and your overall taxable income for this year is lower than it otherwise would be—then you may be in a lower tax bracket this year. Being in a lower tax bracket means that you’ll likely pay less taxes on your conversion than you otherwise would have.
The balance of your Traditional IRA has dropped significantly. When the balance of your Traditional IRA drops, you are able to convert the same number of shares at lower market prices. This means you likely will pay less in taxes than if you converted those same number of shares at higher market prices.
Growth from a global market recovery is better in a Roth IRA than a Traditional IRA. As global markets recover over time, the value of your converted holdings will likely increase. This increase in value will now take place in your Roth IRA, which is the most optimal place for money to grow. Down the line, when you start taking withdrawals out of your Roth IRA, you’ll be able to do so without incurring any taxes.
How to Convert—We Help Make It Easy
We can help you easily convert part or all of your Traditional IRA to a Roth IRA right from within your Betterment account. Just head to Accounts and find your Traditional IRA. On the right-hand side, click the three dots and you’ll see the option to “Convert to Roth IRA.” It generally takes 1-2 business days for Roth conversions to fully complete.
Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
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Can You Have a 401(K) and an IRA?
This is a great question. The answer is yes, you can have both. Should you have both? It depends.
What is the maximum 401(k) contribution?
The IRS recently announced the 2021 401(k) and IRA contribution limits.
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