Over the past weeks, the Coronavirus outbreak has taken over how we work, how we interact with each other, our mobility, healthcare, and economy. The stock market has been volatile and unemployment has escalated. During this time of uncertainty, there are other economic considerations such as whether your IRA should be a traditional IRA or a Roth IRA.
Let’s start with a refresh regarding the difference between a Traditional IRA and a Roth IRA. The biggest difference is when and how the tax break occurs. In Traditional IRAs, contributions are tax-deductible in the year they are made and distributions are taxable when you withdraw money. With the Roth IRA, withdrawals in retirement are not taxed and contributions are not tax-deductible.
The first consideration is whether you think your tax rate will be higher or lower in retirement. In general, if you think your tax rate will be higher in retirement, a Roth IRA may provide greater benefits. If, on the other hand, you anticipate your tax rate to be lower in retirement, then a Traditional IRA may be more beneficial.
Lower Tax Rates in 2020
Because the stock market is low and tax rates are at historic lows, now may be the time to convert to a Roth IRA. You will pay taxes when converting, but if you have saved a considerable amount of money and you think you’ll be in a lower tax bracket in 2020, then this may be the year to convert. An analysis of your current tax situation could result in finding the “sweet spot” of how much you should convert in order to take full advantage of tax bracket planning.
Volatility and Diversification
The stock market has reacted predictably to this unpredictable COVID-19 pandemic with drastic swings. As a result, many IRAs have been negatively impacted. However, though we can’t predict the future, we can look historically at the overall market which has shown swings like we have experienced in the past few weeks to be a temporary situation. If you convert when your IRA has a lower value, you pay taxes on the reduced value and the growth is tax free. Converting to a Roth IRA may also afford you the opportunity to re-examine asset allocation and diversify your portfolio.
Roth IRAs offer more flexibility in terms of early withdrawals (though discouraged), as well as minimum distribution requirements.
There are silver-linings even in the most volatile markets. If you’d like to discuss the tax implications of this or other financial considerations, please reach out.