Sunshine in an otherwise Cloudy Situation – Roth Conversion Opportunity

Written by Philip Lockwood

As many of my clients know I am very keen to making money moves on purpose. In one of my favorite articles I have written I discuss asset LOCATION telling the short fable of two frogs. The story goes like this…. There were two freshly retired frogs, spending their days lounging in a pool, as retired frogs are keen to do. One day, the water suddenly dried up – it probably was poorly maintained by the frog resort. So off they set to find a new place to soak. They passed by a deep well, so full of sparkling water that they could barely see the bottom. The first frog, sick of the sun, prepared to jump in. The second frog, a bit more thoughtful, decided to keep looking, saying ‘Fred, think about it: if this one leaks too, how will we get out of such a deep hole?’ The lesson we’ve so often ignored? Putting all your eggs in one basket, no matter the basket, can have negative consequences.

Many people have chosen or have been ‘educated’ to get their tax breaks now by putting money in tax-deferred investments. Done with consideration this strategy can be a great option for individual investors, but there are other options out there. It is very important to consider your additional options and the role those options will play during the distribution phase of your retirement. If all your ‘water’ is in one well please consider the ramifications if that well sprung a ‘leak’ – in this case, the potential for lost deductions and/or higher taxes could be that leak. I believe a three well strategy can be a good approach to take:

Well #1 being taxable investments. These would include savings and checking accounts, brokerage account, etc.) this well is defined by short term or long-term capital gains tax rates. You put after tax money into these accounts, they grow taxed deferred and when there is a sale in the account you pay either short term or long-term capital gains (depending on the holding period)

Well #2 is tax-deferred investments. Most folks are very familiar with their Traditional IRA, Traditional 401k, 403B, etc.) This well is defined by how the investments are taxed when they are withdrawn. You get a tax deduction when you put money into these investments (up to a certain limit), these investments grow tax deferred and when you pull money out, they are taxed as ordinary income.

Well #3 is your tax-advantaged well. This well can consist of Roth IRA’s, Roth 401k’s, Some Life Insurance Cash Value and Municipal Bonds of your municipality. This well is also defined by how the investments are taxed when withdrawn. You do not get a tax deduction when you put money into these accounts, but these grow tax-deferred (no tax on growth) and these assets are not taxed upon withdrawal.

It is my opinion that each “Well” can play a vital role in one’s retirement plan when they get to the distribution/spending phase of retirement.

The timing of an article like this might seem a bit strange but in reality, I believe this market downturn has provided one of the best times for a Roth Conversion if it suits your current tax bracket. The benefit of doing a Roth conversion now is we know what income tax rates currently are, we know the market has declined significantly from its’ all time high and if history serves as a model we can assume that within the next 5+ years the market will recover. If you do a Roth conversion now the “recovery or gain” in the account would be tax-deferred (no tax as it grows) then the withdrawal would be tax-advantaged (no tax on distribution). This is why a Roth Conversion may be the one rainbow in an otherwise cloudy scenario.

For those of you that may not be old enough to do a Roth Conversion or qualify for a Roth Contribution you now have another 3 months to make contributions for 2019 for other qualified accounts. This is also something to consider.

It is important to remember that past performance does not guarantee future results. Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type. Please consult with your tax professional before any decisions are made.

Securities offered through Parkland Securities, LLC, member FINRA (FINRA.org) and SIPC (SIPC.org). Investment Advisory services offered through SPC, a Registered Investment Advisor. Lockwood Financial Strategies, LLC is independent of Parkland Securities, LLC and SPC

Securities offered through Parkland Securities, LLC, member FINRA/SIPC.