Retirement

Market volatility's silver lining for retirement investors

A silver lining for retirement investors?
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A silver lining for retirement investors?

Despite Wednesday's recovery from steep losses earlier in the week, the major U.S. stock averages are on track for their biggest monthly percentage losses in five years or more. That means your retirement portfolio, your 401(k)s and IRAs, may have lost value as well.

But there may be a silver lining to this market slide. For retirement investors, this could be a great time to convert a traditional IRA to a Roth IRA. A Roth account provides tax-free growth and allows you to withdraw earnings tax-free after age 59½, as long as you've held any Roth IRA for at least five years.

When you convert a tax-deferred, traditional IRA to a Roth IRA, you have to pay income taxes on the money you convert. So a dip in the value of your retirement portfolio means you could save big on taxes you'll pay upfront.

"I love this idea," said Tim Maurer, director of personal finance at BAM Alliance. "You've not so much 'lost'' money in your IRA, but you're taking advantage of a decline, thereby paying less in taxes for the same expected tax-free outcome."

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If you have an old 401(k) from a former employer, you can convert that account to a Roth IRA too.

Just remember, Maurer said, "there will be taxes to pay [on any Roth conversion]."

Some financial advisors caution that converting to a Roth IRA from a traditional IRA may depend more on your tax situation rather than the current market situation.

"Even though the market value of an account went down, it may not mean that the taxes they will pay (on a Roth conversion) would go down by a lot. This is true especially if the investor is currently in a high tax bracket," said Avani Ramnani, director of financial planning and wealth management at Francis Financial in New York.

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Converting to a Roth IRA usually makes the most sense for someone who expects to be in a higher tax bracket when they need money from retirement accounts.

Yet "if the Roth conversion was right for you a few weeks ago, it's probably even more right today," said Jeffrey Levine, a certified public accountant and IRA technical consultant with Ed Slott & Co. "If you're not sure if it's right for you, then do it anyway," he said. "You can decide up until Oct. 15, 2016, to undo a Roth IRA conversion that you make in 2015." (The process of reversing a Roth IRA conversion must be completed by the last date, including extensions, for filing or refiling your prior-year tax return, which is typically on or close to Oct.15.)

The beauty of this "silver lining" strategy is that it doesn't have to be all or nothing. You don't have to convert all of your traditional IRA money to a Roth IRA. Some financial advisors suggest you just convert part of your IRA money to a Roth IRA. That way you've diversified your assets and the tax impact on your retirement accounts.