This is the third in a series of Special Guest posts designed to share ideas from industry consultants and financial advisors. The insights from these industry leaders, we believe, may be helpful as you consider next steps to managing through this crisis and coming out stronger on the other side.
Susan Czochara and Lee Freitag lead the Retirement Solutions Group at Northern Trust Asset Management and are focused on bringing thought provoking research and insights, as well as, investment solutions to help drive better retirement outcomes. They each come with extensive experience in the financial industry, Susan has over 20 years and Lee over 25 years with the most recent decade spent working with plan sponsors, consultants and advisors on providing the right information, tools and investment ideas for retirement investors. Lee in particular has been very connected to our government relations team and broader industry associations to keep the pulse on legislative action impacting retirement.
Susan and Lee joined us on a recent episode of The Flexible Advisor podcast to talk about the CARES Act and what it means for advisors and their clients. In this brief, they dive deeply into the new legislation’s impact around the Roth IRA. Listen to the full podcast here .
In general, investors should refrain from taking panicky actions when the market has plummeted. A better option is to stay the course while the market is stabilizing. Nonetheless, market downturns provide an opportunity to reshuffle assets to strategically manage tax bills. Specifically, a Roth conversion can be a beneficial action for investors who remain calm and thoughtful amidst the market chaos.
The most recent market decline has been steep and quick with the U.S. stock market dropping by 30% in March 2020 from its most recent height. Such magnitude of value decline is painful. However, investors could pause and think whether they want to take advantage of the market dent to make a full or partial Roth conversion. This is not to encourage an exit at the bottom of the market and lock in the loss. Rather, investors could transfer their holdings from a traditional to a Roth account, when account values are likely lower, and thus pay less income tax on the converted assets than in normal times. If history is any guide, the markets will recover and rise over time. By then, the Roth assets will no longer be subject to income tax so the growth and withdrawal of those assets will be tax free.
There is income tax due upon Roth conversions. Conversions count towards adjusted gross income for the year and are subject to ordinary income tax. The CARES Act makes it possible to take a distribution from a traditional 401(k) or IRA to pay the tax without being subject to 10% penalty, if the withdrawal is earlier than age 59 ½ and the owner qualifies for a Corona Related Distribution. However, it is recommended that outside funds be used to cover such tax if possible so that the 401(k)/IRA funds stay intact to grow.
Ownership of both traditional IRA and Roth IRA accounts can accommodate more flexibility allowing investors to coordinate taxable and tax-free withdrawals together with Social Security benefits, to minimize income taxes in retirement. Roth accounts are also not subject to the required minimum distributions (RMD). Finally, Roth accounts can assist with estate planning as owners of Roth accounts effectively prepay income tax for heirs without owing any gift tax or using up the unified federal gift and estate tax exemption. Distributions from inherited Roth accounts are not subject to income taxes.
Looking for a silver lining during market downturns? A declining market environment provides investors with an opportunity to consider the possibility to make a full or partial Roth conversion of their retirement assets. This opportunity, in an otherwise challenging market environment, can nudge investors to take action and move assets to a Roth framework which may lead to significant financial benefits into the future.
If you’d like to learn more about these and other retirement and investment-related topics, please visit the Northern Trust Asset Management Investment Institute. To hear and read more content like this, subscribe to The Flexible Advisor Podcast or to receive an email when new briefs are available.