Skip to main content

Benefit from Market Losses by Helping Your Retirement Account

By Dr. Shelby Smith
of The Retirement Pros

The Dow Jones Industrial Average (a hallmark of stock market performance) opened 2008 at 13,044 and closed the year at 8,776 – a 33% drop for the year.?Is has dropped another 7% in the New Year.?If your retirementmoney was, or is, in the market you’ve suffered a comparable or greater loss.?Your market losses may be a blessing in disguise if your 2009 taxable income will not be over $100,000. Let’s see how.

If you do not make more than $100,000 in 2009 you can convert your IRA (or other retirement accounts) to a Roth IRA.?If your 2009 income will exceed $100,000, see the last paragraph.?Parenthetically, if your retirement money can be moved, you can easily convert directly to a Roth IRA.?If still working, you can transfer retirement money in your employer-sponsored plan provided it has an in-service, non-hardship withdrawal provision. If your plan does not allow transfer before retirement, petition your employer to make the simple change that permits in-service transfers. The amount converted to a Roth IRA will be taxable income when you file your 2009 tax return.?Believe it or not, the dark cloud of market loss has a silver lining.

Since your retirement account shrank in 2008, the taxes resulting from a Roth IRA conversion will also shrink.?Additionally, if you think future tax rates will rise due to the over-sized government spending to resuscitate the economy and the other looming unfunded liabilities (Social Security, Medicare, Medicaid, etc.), converting to a Roth IRA now makes double good sense.?By the way, once your retirement money is converted to a Roth IRA, the principal amount and all earnings will be tax free forever – even if you leave it to your heirs.?It is not necessary to convert all of your retirement money since partial conversions to a Roth are permitted.?Also, the required minimum distributions (RMD) normally required on retirement accounts (Congress has waived the RMD for 2009 so hard-press retirees won’t have to take money and compound their current losses) do not apply to Roth IRA.?But what if your account continues to sink in value once you convert to a Roth IRA?

If the market continues to lose ground and your retirement money shrinks further, you can “recharacterize” back to a traditional IRA anytime before you file your 2009 tax return (latest date with extension is October 15, 2010).?This gives you a “free look” for almost two years.?If the account you converted goes up in value, you have benefited by converting to a Roth IRA because (a) you paid fewer taxes since your account has been reduced by market losses, and (b) all post-conversion gains are tax free.?On the other hand, if the account you converted to a Roth IRA continues to lose you “recharaterize” back to the original IRA and pay no taxes.?If you recharacterized, you can later convert to a Roth IRA and pay even fewer taxes. This is the proverbial “free lunch” and you should eat heartedly before the meal is taken away.

In 2010 the $100,000 income limit is scheduled to be suspended; thus, everyone will qualify for a Roth IRA conversion.?Also, the taxes due on a 2010 conversion can be paid over two years: one-half in 2011 and the remainder in 2012.?Even if your market investments do recover soon – not likely in my opinion – there remains several great reasons to convert to a Roth IRA: no income taxes on Roth withdrawals will ever be paid by your family or your heirs; no required minimum distribution; Roth withdrawals are not currently counted as income when computing taxes on your Social Security benefits, and more. You should immediately investigate the feasibility of converting to a Roth IRA because this “free lunch” may come off the table at any time.

Shelby J. Smith, Ph.D.
January 2009



Popular Video