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The Case for Roth Conversions in Light of the SECURE Act and Current Financial Market Conditions


2019's SECURE Act contains two provisions that make converting IRAs and retirement plan accounts to Roths more attractive:

The first of these is that SECURE increases the age at which required minimum distributions must start from 70 1/2 to 72.  All else being equal, Roth conversions are more attractive the lower the account owner's current tax rate is relative to that of her (or her beneficiary's) future tax rate.  Since most retirees are in relatively low-income years after retirement but before RMDs kick in, this provision of the Act allows these owners of tax-qualified accounts an extra year or two in this "sweet spot" to perform Roth conversions.  And now with more of these low-income years over which to spread partial Roth conversions, there is more of a chance to avoid some of the potential negative by-products of this strategy.

Second, the SECURE Act gets rid of the "stretch IRA" for many beneficiaries.  Unless inheritors of tax-qualified accounts are deemed to be "eligible" as defined in the Act, they now have to empty these accounts within 10 years. To avoid being pushed into even higher tax brackets and to avoid some of the other adverse knock-on effects of having higher incomes, many ineligible beneficiaries will want to spread these distributions fairly evenly over this 10-year period.  In effect, then, there will be very little remaining tax deferral on a portion of these inherited account balances once the original owners pass away.  By contrast, if the original owners had instead converted these tax-qualified account balances to Roths while still alive, their ineligible beneficiaries could opt to wait until the end of the 10th year to distribute the entire inherited account balances tax-free, gaining years of tax deferral in the process.

Current Financial Market Conditions

All else being equal, Roth conversions are also more attractive the higher the expected future returns of the retirement account balance being converted.  As alluded to above, Roth conversions are not an "all or nothing" proposition.  Owners of more than one tax-qualified account may not only choose which of them to convert, but at least in the case of IRA's, how much of each individual holding within each account to convert.  Since returns on asset classes and on mutual funds tend to revert to the mean, holdings within an IRA that have not performed very well during the last few years may be prime candidates for conversion.  Not only should their future expected returns be relatively high on balance, but the dollar values of these holdings (which determine the tax bill due from the conversion process) should be relatively low.

If we apply these guidelines to what's been going on in the financial markets in the past year, it may seem like we've missed the boat with respect to Roth conversions.  Certainly in retrospect, account balances were more depressed a year ago, which would have been an attractive time to convert, and many investment holdings have now fully rebounded to pre-pandemic values and even to all-time highs.  However, many asset classes and mutual fund investment styles have still languished in recent years.  In this respect, investments in small-cap value funds, in international and emerging markets value funds, and in commodities, may still offer attractive opportunities for conversions into Roth accounts.

About the Author

Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.

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