Should I Do A Roth Conversion When The Market Is UP or When The Market Is DOWN?

Troy Sharpe: When should you do a Roth conversion? We do tons of tax planning videos on this channel for your retirement to help you make better decisions, but should you be doing your Roth conversions when the market is up at the end of the year typically like most people do, or should you consider doing them throughout the year, especially when the market is down?

Troy Sharpe: Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, Certified Financial Planner professional, a certified tax specialist, and also host to the Retirement Income Show that you can hear right here on YouTube. We introduced this concept several years ago to clients about when we do Roth conversions and why we do the Roth conversions at that time. Today, I’m going to walk you through the simple math and then the concepts behind it so you can decide if it makes sense for your retirement as well. If you want to make better decisions with money, if you want to learn more about investing, taxes, all of these topics, hit that subscribe button.

We’re going to do just that for you, it takes a second and doesn’t cost you anything. All right, we’re going to start by showing you two different portfolios here. One on the left assumes this is the value of your IRA at the end of the year. To keep it uniform, we’re looking at a $1,000,000 portfolio and assuming that everything in there is simply valued at $100 per share. That means we have 10,000 shares of stock at $100 per share, which equals $1 million. Over here on this side, we have the same portfolio but this is showing in a year like right now where the market is down, which we expect long-term capital markets to go up.

Mid-year or earlier, at some point during the 12-month cycle, the portfolio is down. When we talk about stock ownership, investing in the markets, we ask clients to believe a couple of things, first and foremost, that capital markets work. That long-term, we expect capital markets to be worth more or the securities within capital markets to be worth more than they are today. Then number two, whatever stocks we own, whatever risk investments that we own, we have to understand that one, they need to be part of a plan, but two, they are just tools to help accomplish the goals that that plan has set out to do. Now when you own stock, it’s important to look at the stock you own as an asset.

Try to dissociate yourself away from just the value of the portfolio. Look at yourself as an owner, you have a right to the property. You have a right to the profits, you have a right to the assets of that company. You are an owner when you invest in publicly traded equities. When we look at it from that side, yes, the portfolio value is worth a million, but truth of the matter is we own 10,000 shares of those companies. Don’t look at it as a value. If you look at it as an ownership, from a shared ownership perspective, first and foremost, that’s going to help you withstand the ups and downs in the market much more easily.

Number two, it helps to understand this concept of why we would recommend we do Roth conversions in times when the market is down, as opposed to at the end of the year just going and doing it in November or December. We’re owners of companies, we have the rights to the assets of the companies we own within our portfolio. 10,000 shares, 10,000 shares. Even though the value is down, we still own 10,000 shares. What happens when the market goes down? Do you lose any shares of the companies that you own? No, of course, not. Just temporarily the value, the fair market value of your slice of those companies has decreased in value, but you still own the shares.

That’s what I mean when I say this is the portfolio at the end of the year because the portfolio has now rebounded and typically this is when either if you’re doing it yourself or if you’re working with a financial advisor, if the financial advisor is having these conversations with you. Typically this is when most people are going to do their Roth conversions, and I think it’s a missed opportunity and this is why we do it this way with our clients. Here is, let’s say it’s May of the year so mid-year, portfolio has gone down in value. We still have 10,000 shares but the current market value is $800,000, estimated at $80 per share.

Assuming our income and tax plan calls for a $100,000 conversion, I’m going to look at both scenarios and do a comparison to help you understand the difference between the timing of Roth conversions can have on the portfolio today, and also long term. $100,000 conversion. If you’re new to the YouTube channel and you haven’t seen some of our Roth conversion videos when it comes to personal retirement planning, the impact they can have on your income and taxes over the course of retirement, they’re some of the most powerful and educational videos I believe out here on YouTube when it comes to retirement planning.

I strongly encourage you after this video to go watch them so you can understand long-term, have context to how these decisions today can help improve retirement over the long haul. I’m talking hundreds of thousands of dollars in many scenarios of potential taxes saved. When we put together an income plan and a tax plan for clients, oftentimes we’re looking at Roth conversions because we want to look at taxes long-term. Depending on how much income you have, your other investments, any rental property, social security, pensions, all of these aspects, they affect the tax plan because they determine where we are in our tax brackets.

If we’ve put this plan together and it calls for the client to do $100,000 conversions, sometimes it might be for two or three years, other times, it might be for four or five or six. Heck, even the conversions, the dollar amount of the conversions may be $100,000 for one, two, three years, and then a reduction to 80, 70, 60. Everyone’s plan is customized, and everything is different for your situation. I want to keep this simple for purposes of this video and assume we’re just doing $100,000 conversion, because that is what the plan calls for. We have two choices. We can wait until the end of the year to do the conversion, or we can take advantage of the market drops and do it now.

In this example, if we do the $100,000 conversion, the IRA at the end of the year drops to $900,000 because we’ve moved $100,000 over to the Roth. Pretty simple math here. We have 9,000 shares left in the IRA. We’ve moved 1,000 shares over because they’re valued at $100 per share in this example. End result, we have $100,000 in the Roth, we have $900,000 in the IRA. This is the breakdown of shares amongst the accounts. The tax bill for both of these situations is the same because we’ve targeted $100,000 conversion amount.

In this example, if we take advantage of the pullback in the market mid year, remember it went from $1,000,000 to $800,000. We’re still targeting that $100,000 conversion. After we do the conversion, we’ll have $100,000 in the Roth, same as over here. $700,000 in the IRA because of the market drop. Here is the big difference. We have been able to move because the price per share is lower- because the market has come down, we’re able to move more shares into the Roth. In this example, we have 1,250 shares as opposed to 1,000 in the Roth. We’re left with 8,750 as opposed to 9,000 in the IRA.

Now, why is this important? Getting this extra 250 shares into the Roth, remember we asked you to believe that long-term markets go up, so we do believe that long-term these shares are going to be worth more. We got 250 more shares in here, and essentially, did not have to pay tax on them because if we waited to the end of the year and did the conversion of $100,000, we only get 1,000 shares inside the Roth. Whereas, if we were more proactive with our tax planning and we took advantage of the opportunity when the market was down, we’re able to pay the same cost that $100,000 tax bill for the conversion, but we’re able to get more shares over here.
If we believe long-term the markets will be higher, then this 250 shares when it rebounds back up to 100 per share, that’s an extra $25,000 inside the Roth, which again, essentially we didn’t have to pay taxes on. Now, we do have to pay taxes on the $100,000, but you get my point. Now, here’s the part that I think a lot of people overlook, and it’s really two-fold. First and foremost, I’m a finance guy. I’m not just looking at the power of the decisions that we make today, I’m considering with everything that we do for clients what is the power of those decisions over time? The power of those decisions that we make today, what is the power and the value over time? This is called the time value of money.

An extra 250 shares, once the market rebounds and our portfolio gets up to its previous levels, we just said that that’s about $25,000. If we compound that additional money in the Roth at 7% over the next 20 years, that’s actually $100,000 in value. We’ve actually gotten $100,000 more into the Roth over time, assuming the 7% rate of return. Again, theoretically, we really didn’t have to pay tax on this money because we simply did the conversion in the middle of the year as opposed to the end of the year. Now, the two-fold part here is not only do we have a higher value than what we actually got into the portfolio today when we’re looking at the time value of this decision, but we also have less money inside the IRA.

If you’re a follower of this channel, this is why I told you to go watch some of these other Roth conversion videos if you’re a first time viewer here, is we’ve got- and essentially this $100,000 that would have been in the IRA, we’ve got it into the Roth. What does that mean? We have a less ballooned IRA down the road, which means our requirement on distributions are going to be lower, and almost certainly, our income taxes later are going to be lower. Not only do we have the benefit today, but we get the benefit down the road with respect to our IRA and income taxes with regard to required minimum distributions.

All around, I think this is a much better strategy than just waiting until the end of the year to do your conversions. Is it better to do your conversions when the market is up or when the market is down? Well, I believe it’s better to do them when the market is down. Comment down below, let me know what you think. Of course, subscribe to channel. Our goal is to keep you more connected to your money, and we do that by you staying more connected to us. Like the video, and we look forward to seeing you on the next one.