The best time for this retirement savings move is during a down economy

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Hanna Horvath, CFP®

Hanna Horvath, CFP®

Managing Editor & Certified Financial Planner™

Hanna Horvath, CFP®, is a certified financial planner and former managing editor at Policygenius. Her work has also been featured in NBC News, Business Insider, Inc. Magazine, CNBC, Best Company, and HerMoney.

Published May 20, 2020 | 3 min read

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The COVID-19 crisis is shaking up workers’ retirement plans. One way to protect your nest egg is to convert a traditional retirement account to a Roth IRA.

It’ll cost you up front in taxes, but if you can afford the bill, now may be the perfect time to do a Roth conversion, despite the slumping economy. It’s more affordable than ever: Tax rates are low and your retirement savings — and current income — may have taken a recent hit. Here’s what you need to know about Roth IRAs and why now is a good time to convert.

What is the difference between a Roth IRA & a traditional retirement account?

Roth IRAs are retirement savings accounts funded with after-tax dollars. You’ll pay taxes up front on contributions, so you won’t have to pay taxes on money you withdraw in retirement, unlike 401(k)s or traditional IRAs.

The tax advantages of Roth IRAs are beneficial if you expect to retire in a higher tax bracket than you’re in now, which is common since many people earn more later in their careers than at the beginning, said Scott Hughes, certified financial planner and advisor at Hughes Financial Services. But now may be an especially good time to switch to a Roth. Here’s why.

Tax rates are low

Taxpayers have the chance to take advantage of historically low tax rates, thanks to the 2017 Tax Cuts and Jobs Act. These tax cuts are set to expire at the end of 2025, said Alex Koury, certified financial planner and advisor at Hosler Wealth Management. Even if you plan to retire in the next decade, it may be smart to capitalize on today’slow rates.

“It is to most people's advantage to consider creating a Roth conversion strategy and pay taxes now, utilize these lowest marginal tax rates and never pay taxes again on these retirement funds,” said Koury.

The national debt has increased significantly since the beginning of the crisis, and Koury expects the U.S. government to eventually raise taxes to offset the damage.

“When taxes go up, those extra dollars go to pay the national debt, not an individual's retirement,” he said.

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Your account balance (& income) may be lower

When you convert a traditional IRA or retirement plan to a Roth IRA, you’ll have to pay income taxes on the entire account balance.

This may be one of the best times to pay that tax bill. The market is down, so your account balance is lower — and the tax bill to convert your account will be much smaller.

Markets will recover. You have depressed market values in your tax-deferred IRAs and 401(k)s, so converting at lower value will reap the benefits of the future surge inside a tax-free account,” said Marianela Collado, certified financial planner and advisor at Tobias Financial Advisors. “Your retirement accounts will likely return to their original value, and you already paid all the taxes on the account.”

Taxpayers who may have recently experienced a reduction in pay or job loss may find themselves in a lower tax bracket, which means a Roth conversion may “cost” less, said Collado.

How to decide if a Roth conversion is right for you

If you believe tax rates will go up and want to take advantage of the current market instability, it’s a smart move to convert your retirement account to a Roth IRA. You’ll pay a larger sum up-front, but you’ll save potentially thousands come retirement.

So if you have some years to go before retirement and are able to foot the bill, a one-time payment in a Roth conversion may be a smart money move in return for tax-free distributions in retirement.

How to convert a traditional retirement account to a Roth IRA

First: Open a Roth IRA. Here's how. Here are some of your rollover options.

  • Indirect rollover. The money in your old retirement plan will be sent directly to you via check. You have 60 days to deposit the distribution into a Roth IRA.

  • Trustee-to-trustee transfer. The financial institution that currently holds your traditional retirement account moves the money into a Roth IRA at a different financial institution.

  • Same-trustee transfer. The financial institution that currently holds your traditional retirement account moves the money to a Roth IRA within their institution.

Remember, when you roll over a traditional retirement plan into a Roth IRA, you’ll owe taxes on the entire account balance. Because of the potentially complex tax implications, it’s a good idea to talk to a financial professional before making this move. Learn more about rolling over a retirement plan here.

Image: Arnel Hasanovic