The weak stock market might be an opportunity for taxpayers who want to convert their taxable traditional retirement accounts to tax-free Roth accounts.
On Monday, April 21, 2025, the S&P 500 sank 2.4%. The index at the center of many 401(k) accounts has retreated 16% below its record set two months ago.
The other stock market indexes, bond prices (including U.S. Treasury bonds) and the dollar have also fallen.
Reasons for the market weakness might be uncertainty as a result of President Trump’s imposition of tariffs of 145% to 245% on imports from China, broad-based 10% tariffs on other imports, and more tariffs on imports from other countries after a 90-day pause, together with his threat to fire Federal Reserve Chair Jerome Powell. Firing Chairman Powell threatens the independence of the Federal Reserve, which helps stabilize world financial markets.
With securities prices down, this could be a great time to make a Roth conversion.
What if securities prices fall even more? Timing financial decisions is problematic. Securities prices could fall even more if Trump actually fires Chairman Powell and goes ahead with many of Trump’s proposed tariffs that have been “paused.” Securities prices could improve if Trump reconsiders these threats and proposals and decides to not go ahead with them. Or, something else could happen. We just don’t know what will happen in the future.
We do know prices have already fallen, creating a potential opportunity to save taxes with a Roth conversion.
Why make a Roth conversion?
- After a short waiting period, most earnings and appreciation inside a Roth account are tax-free. . The earnings and appreciation inside a traditional retirement account are tax-deferred until distributions are made. (There is an exception for “unrelated business taxable income” that doesn’t apply to most taxpayers.)
2. Distributions from a Roth account after age 59 1/2 are tax-free, and so are many distributions before age 59 1/2. Distributions from a traditional retirement account in excess of any non-deductible contributions are generally taxable.
3. There are no required minimum distributions for a Roth account during the lifetime of the account owner (unless the retirement plan specifies otherwise.) Required minimum distributions generally must be made from a traditional retirement account when the account owner reaches the “applicable age”, currently age 73.
4. When the account owner dies after the required beginning date (April 1 of the year after reaching the “applicable age”), required minimum distributions must be made to the beneficiaries of a traditional retirement account. Since there is no required beginning date for Roth accounts (except Designated Roth Accounts of some employer plans), required minimum distributions don’t apply for most inherited Roth accounts. (Inherited Designated Roth Accounts can be rolled over to beneficiary Roth IRA accounts to avoid having to make required minimum distributions.) (Both traditional and Roth retirement accounts are subject to the requirement to be distributed by the end of the tenth year after the death of the account owner, with some exceptions.)
5. Distributions to beneficiaries from inherited Roth accounts are generally tax-free. Distributions to beneficiaries from inherited traditional retirement accounts are generally taxable, except for the recovery of any nondeductible contributions.
Since required minimum distributions don’t qualify for Roth conversions, taxpayers who have reached their required beginning date MUST TAKE THEIR REQUIRED MINIMUM DISTRIBUTION FOR THE YEAR BEFORE MAKING A ROTH CONVERSION.
A Roth conversion is currently taxable. Planning to have the cash available to pay the income taxes relating to the conversion is critical. You might want to consult with a tax consultant or financial planner to estimate in advance what the tax will be and decide how much to convert.
There can be other “side effects” of a conversion. For example, the additional income can reduce itemized deductions for medical expenses and can result in higher Medicare premiums. Get advice to “look before you leap.”
Now that tax return filing season is over, it’s tax planning season. Whether to make a Roth conversion during 2025 should be a topic on the agenda for a tax planning meeting for everyone who has a traditional retirement account.