Financial Planning – What to Consider if Your IRA Portfolio Takes a Nosedive
What to Consider if Your IRA Portfolio Takes a Nosedive
The first half of 2020 has been marked by historical levels of volatility on the way down… and up. During the steep drawdown in March our financial advisors were focused on trying to find productive ways to help our clients. One of the key discussions in March, revolved around taking advantage of the draw down in asset values to perform a “Roth Conversion” – a strategy we would like to dive into below.
The Roth Conversion strategy Can be considered if you have a Traditional Individual Retirement Account (IRA) or a Traditional 401k from a PREVIOUS employer. If the only retirement account you have is held through your current employer, you will not be able to implement this strategy. The main motivation of the Roth Conversion strategy is to move assets that would be subject to regular income tax upon withdrawal (Traditional IRA/401k) into an account that would be subject to no tax by Federal, State or Local entities (Roth IRA). While this strategy seems to be an automatic, there are a few items to consider before moving forward.
The first item for consideration with the conversion is whether all or part of the assets in the Traditional IRA/401k will be subject to taxation? If contributions were made to the IRA on a Tax-Deductible basis, then those assets will be subject to regular income taxation (Subject to your marginal Federal and State tax bracket) upon the conversion. If contributions were made on a Non-Deductible Basis, then the contributions would not be subject to tax upon the conversion, but the earnings in the account would be subject to regular income taxation upon conversion. The second item to consider is, if tax will be owed – how do you plan to pay that liability? Ideally you do not want to “Withhold” taxes out of the IRA/401k assets that are being converted, that way the maximum amount of dollars can be converted into the Roth IRA. Instead you want to pay the tax liability from a taxable account (Checking, Savings, Brokerage, etc.). Finally, from a timing perspective, if you own assets in the Traditional IRA/401k account it would make more sense to convert those assets (Which would be subject to taxation) during a time when their values are depressed temporarily in the market… once those assets have been moved to the Roth IRA and rebound, that growth will occur in the Roth IRA, absent from taxation during accrual and eventually withdrawal. An illustration below provides an example of the drawn down we recently experience in the first half of 2020. The benefit to making a Roth conversion when your portfolio is down is simple – to save money on taxes.
For simplicity, let us assume your marginal tax brackets for both Federal and State taxes total to 30% when combining the two. When looking at this hypothetical performance history in the illustration above, we can see the account hit $25,360 in mid-February and then hit a low of $16,382 at the end of March. If this person were lucky enough to have made the Roth conversion at that low mark, their taxes due would have been $4,914.60 ($16,382 x 30%). Compare this to making a conversion at the peak of the market and their tax bill would have been $7,608 ($25,360 x 30%). Making a conversion at the bottom of the market would have saved this person right around $2,700.
While volatility is always unnerving, we do the best to assist our clients in trying to take advantage of the chaos by finding value added strategies to assist them in building and protecting their hard-earned wealth. A Roth Conversion strategy may not be beneficial to everyone, we know our clients appreciate our creative planning approach to complex problems. If you are interested in having our team review this strategy considering your unique situation, please feel free to reach out so we can discuss your situation further.
Michael Souza & Chad Williamson
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130
This material should not be considered a recommendation to buy or sell securities or a guarantee of future results. Koa Wealth Management, LLC is a registered investment adviser. Registration does not imply a certain level of skill or training. More information about Koa Wealth Management, LLC can be found in our Form ADV Part 2, which is available upon request or by visiting our website at www.koawealth.com/disclosure. Past performance is not a guarantee of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions, or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.