How a Roth IRA Conversion Will Help Your Investments During a Bear Market

A bear market isn’t just a time to go crawling into your investment hibernation until the bear finally leaves; it’s also an opportunity to take advantage of certain forces that work in your favor.

One of those forces has to do with a Roth IRA conversion. As The Wall Street Journal recently noted, when the value of assets such as stocks and funds fall, the taxes on conversions to Roth IRAs often drop as well. This means converting to a Roth IRA during a bear market increases your potential for asset growth and tax-free withdrawals.

For those who need a refresher course in retirement plans, a Roth IRA is a qualified individual retirement account that allows you to grow investments tax-free. You contribute money you’ve already paid taxes on.

That’s the opposite of a traditional IRA or 401(k), in which you don’t pay taxes on money you contribute but do owe income tax on any withdrawals. There’s also no required distribution from your Roth IRA, unlike a traditional IRA or 401(k), which require you to begin making withdrawals beginning at age 72.

Roth IRA conversions have become increasingly popular over the last few years. Taxpayers reported 892,000 Roth conversions totaling nearly $17 billion in 2019, the WSJ reported, citing IRS data. That’s well up from just five years earlier, when 489,000 taxpayers converted about $8 billion. Conversions have been especially popular with Americans who earn $200,000 to $500,000 a year.

As the name suggests, a Roth conversion involves moving assets from a traditional IRA to a Roth IRA and then paying income tax on the transfer. The tax bill can get pretty high, depending on the dollar amount of assets being transferred. But converting when prices are down — like during the bear market — reduces your tax burden.

If the tax rate on the Roth IRA conversion is lower than the expected rate when the assets would be withdrawn, a conversion makes sense. On the other hand, if the tax rate at conversion is higher than the expected rate at withdrawal, it might not be such a great move.

That’s why it’s important to do Roth conversions during years when tax rates are low. Many financial advisors recommend doing partial Roth conversions over several years to avoid income that can push you into a higher tax bracket.