At this point, most investors have recovered the majority of their losses from the COVID-19 pandemic shock back in March. And while it appears that markets have generally returned to their pre-pandemic levels, you see a much different engine when you look under the hood.
For example, the Technology sector is up nearly 30% year to date while the Energy sector is down nearly 50% on the year. Consumer Discretionary is up 25% in 2020 while the Financial sector is down more than 20%. Perhaps most surprisingly, growth stocks are up an average of 20% while value stocks are down an average of 20%.
Given that such a wide disparity can have a tremendous impact on your investment performance, it is important to rebalance your portfolio during such volatile times. Unfortunately, the rebalancing process may not always be sufficient. Another important consideration may be a Roth conversion.
First and foremost, a Roth conversion takes pre-tax investments from a traditional IRA and converts them to after-tax investments that can continue to grow tax-free until withdrawn. Investors should carefully look at their situation and consult their tax adviser before making any moves. Typically, a Roth conversion is considered a taxable event with ordinary income tax due on the amount converted in the year of the conversion, which could be a great benefit to those concerned about future tax rates and those who do not have sources of tax-free income in retirement.
The benefit of considering a Roth conversion during times like this is that investors can take high-quality holdings that have recently suffered and convert a greater amount of those positions to after-tax savings. If you have carefully crafted your portfolio with a financial adviser, these holdings are likely poised to recover as the economy changes. They also have a specific place in your overall financial plan.
Converting sector-specific stocks while they are underperforming can allow you to convert more shares while paying less tax on the conversion. Consider that today’s tax rates are likely at their lowest. We are on the brink of an election, which could result in tax law changes should the administration change. Furthermore, with the amount of stimulus the government has created to sustain our economy through the pandemic shutdowns, taxes are more than likely to increase in the future.
One key to a successful Roth conversion is to specify to your custodian that you want to “transfer-in-kind.” This means your custodian will move the shares as-is, rather than selling them for cash, which would lock in your loss. You will also need money outside of the IRA accounts to pay the tax due. If you work closely with your financial adviser and tax consultant, you can convert just enough stock to a Roth IRA without bumping you into a new tax bracket.
As an added benefit, if you are close to age 72, you’ll also be reducing the balance in your traditional IRA, which could reduce your required minimum distributions in the future. If RMD age of 72 is several years away, you still benefit: you should be able to withdraw contributions both tax free and penalty free so long as you’ve held the Roth IRA for five years.
If you are interested in seeing if a Roth IRA conversion will work for your situation and portfolio holdings, the experts at Henssler Financial will be glad to help: