Seize the Opportunity to Convert to Roths

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. If there's a small silver lining in the recent market slide, it's that converting traditional IRA balances to Roth may cost you less in taxes than would've been the case even a few months ago. Joining me to discuss that topic is Ed Slott. He's a tax and retirement planning expert.

Ed, thank you so much for being here.

Ed Slott: Thanks, Christine. Great to be here.

Benz: Ed, let's talk about the benefits of converting from a traditional to a Roth IRA. Why would I want to consider that?

Slott: Well, because it's all a play on the tax rates, but now you have another factor, as you mentioned. Values are low and tax rates are low. That's the perfect scenario for a Roth conversion. If you believe both will go up, and I do believe both the market will go up, and there's no question the tax rates will go up. I mean, they just spent $2 trillion. I don't know if you saw, unlike other bills, there were no revenue offsets in this bill. In other words, there was a part where they say how they're going to pay for it. That's out the window. There's just no way they're going to pay for it other than, I think, future tax increases. Plus, we're already scheduled after 2025 for the current low tax rates we have to be increased back up to the prior levels.

So you have a good situation now, as you said, a silver lining, where, if you have the money--remember, you still have to pay tax on the conversion, and given what's going on in the world, you have to reassess whether you can afford to pay the tax. Because, as you recall, from a couple of years ago, tax law, there's no do-overs with Roth conversions. Once you convert, you will owe the tax. So first make sure, after you first evaluate it and believe you may really see a benefit here with low rates and low values, make sure you project the tax bill and you have the money, or you will have the money, by tax time next year to pay the bill.

Benz: A question, I think, people might be mulling right now is, you're saying to compare your current tax rate to the future. But if my retirement is many years into the future, if I'm a retirement saver with, say, 20 years until retirement, how do I begin to get my arms around this issue about whether my tax rate today is lower than what it could be when I withdraw the money in retirement?

Slott: Well, tax rates, historically today, are the lowest they've pretty much ever been in anyone's lifetime. There's no question about that. And I also think there's no question that tax rates in the future will have to be higher. Remember, the Roth conversion works if your tax rate in the future is at least the same or higher than it is now, then you get that benefit.

So what's the downside? Let's say you converted and your tax rate turns out to be lower. It's not going be lower than 0%. That's your worst-case scenario. You're at a 0% tax rate on the Roth money. That's locked in. So I don't think there's much risk there, again, if you're comfortable paying the tax upfront. I think this is a great time, a very opportune time, to take advantage of some terrible situations. Well, one is the low values, but one other good situation is the low rates. The combination of two makes for a good Roth conversion strategy.

Benz: When you say make sure you have the taxes, that means you'd want to have those funds external from the IRA. You wouldn't want to have to pull out extra.

Slott: Exactly right. It doesn't work as well if you have to take it out of the money you're converting. It's just not efficient. So you would have to have other money. You don't have to, but I would say pay the taxes from other funds that have those funds available. You may even want to start maybe looking at your projected tax rates, and you don't have to convert everything. Most people hear this, they say, "Oh, I don't want to convert. It's a big tax bill." So convert enough to use up at least the lower tax brackets. If you don't use them, they're wasted. You don't get them back next year.

Benz: It seems like this would be a spot to get some tax advice. Potentially consider a series of these conversions over a period of years?

Slott: Yeah, that's exactly what I'm telling people. Start a series of smaller annual conversions, using up these lower brackets and rates while they're here.

Benz: Ed, good topic. Thank you so much for taking time out of your schedule to be here with us today.

Slott: Thanks, Christine.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.

i