I recently tuned into the Valspar Championship. Tiger Woods was in the running for the winner’s purse for the first time since 2013. Some aspects of Tiger had not changed. He energized the crowd in a way that no other golfer does. And he continued with his Sunday tradition of wearing red. What did stand out to me was the difference in the style of his game. Following Tiger’s numerous injuries, he now must depend on shorter, more strategic shots as opposed to powerful drives down the fairway. These necessary adjustments in Tiger’s golf game reminded me of how we’ve made financial adjustments in retirement portfolios – specifically, our shifted mindset towards executing Roth conversions.
As a refresher, a Roth conversion occurs when you move assets from a Traditional IRA to a Roth IRA. Money within a Traditional IRA is pre-tax, so you pay ordinary income taxes now on the amount converted. This is beneficial because those dollars will continue to grow tax-deferred and future distributions are tax-free. Roth IRAs serve as a reliant estate planning vehicle as well because the tax-deferred growth and tax-free distributions are passed on to the beneficiary (oftentimes the next generation) in the event of the account owner’s death.
The new tax law has eliminated an investor’s ability to perform recharacterizations. A recharacterization worked like a mulligan (in golf language this means a do-over) and was recommended when the Roth performed poorly after paying taxes upon the conversion. For non-golf enthusiasts, a mulligan is essentially a redo that a player may take if their original shot was off course. With the ability to recharacterize, we as fiduciary advisors were recommending that clients execute multiple Roth conversions each year. Each conversion would be funded with a particular asset class or concentrated stock because we could keep those that performed strongly and recharacterize those that did not. Like Tiger, certain events (the new tax law) forced us to change our approach to the game.
Our New Game Plan
Since taxpayers no longer have the ability to recharacterize, executing multiple conversions in a year is not the best strategy. Historically, the market has gone up more than it has gone down, so investors should have their money working for them as many days as possible. Large, lump sum Roth conversions help to accomplish this. You have a higher probability of catching an upswing in the market by converting $100,000 at once versus $25,000 on four separate occasions throughout the year.
This can also work against you in the short-term and you may be faced with regret risk. It is possible that you pay taxes to convert $100,000 to a Roth and the market dives 20%. Your $100,000 is then worth $80,000 and you may kick yourself for paying taxes on the higher amount. Roth IRAs should be viewed as long-term money and a short-term market drop will not deem that conversion worthless. If Tiger drives a tee shot out of bounds, he will likely have a poor score for the hole, but that does not necessarily ruin his entire round. The longer those dollars grow tax-deferred, the larger the benefit of having the Roth becomes.
We also now advise against using one specific asset class or company’s stock to fund these large Roth conversions. Converting a diversified collection of assets should help from a risk standpoint. If one asset class is lagging in terms of performance, the other asset classes that were converted with it can pick up the slack. Tiger would never show up to the course with one or two clubs in his bag. He knows that it’s possible he could end up in deep rough or a sand trap, so he has the proper tools to help get him out of those situations.
When is a Roth conversion appropriate?
Whether or not a Roth conversion is appropriate is still dependent on an individual’s or couple’s tax situation in any given year. Since you are forced to pay ordinary income taxes on the dollars converted, Roth conversions likely do not make sense for those employed with high earnings or if a minimal amount of additional income will push you into the next tax bracket. RegentAtlantic works as a team with our clients’ accountants, much like Tiger and his caddy read a green. We survey your income tax picture each year and determine if a Roth conversion makes sense at that time.
Please contact your Wealth Advisor and/or accountant if you would like to have a deeper discussion about how a Roth conversion may fit into your overall financial picture.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.