Converting From a Traditional IRA to a Roth: Timing

If you think, as I do, that your income tax rate may be higher after you retire, then you’re a candidate for converting a portion of your Traditional IRA into a Roth IRA.

In the previous post I discussed why you might want to move money from your Traditional IRA to your Roth and some considerations for determining the amount to move (convert).

When you move cash from your IRA to your Roth, timing is not a consideration. However, if you move securities you should know that your tax liability is determined by the value of the securities at the time of the move. Your cost basis (what you paid) is irrelevant; so is the price at which you eventually sell the stock.

Because of this feature, when I moved securities from my IRA to my Roth last year, I did it in the early Spring because the entire market was significantly down. This allowed me to move more shares for the same tax liability than if I’d made the move later in the year.

For example, suppose you held 100 shares of XYZ company in your IRA that you’d originally purchased for $10 per share. Your cost basis for this stock is 100 shares times $10 per share or $1,000. If today, the price of XYZ stock is $5 per share and you convert all 100 shares into your Roth, your tax liability is your tax rate on $500.
If later, the price of XYZ increases to $12 and the value of your holding in your Roth account becomes $1200, it doesn’t matter because your tax liability remains the tax on the $500 value at the time of conversion.

Last year, the situation was pretty clear. The market had crashed and everything was down. I had confidence that my stock would rise again although I didn’t know when. Today, in 2010, it’s a bit less certain. The market is up substantially from last March. Some people think we’re in a new bull market. Others expect another leg of recession. Still others think the market is simply overvalued right now and expect a correction.

I expect another leg down to match a “W” recession and an extended “L” shaped recovery after the second downturn. If I were certain in this opinion I’d wait to move shares to my Roth until after the next crash.

However, I’m not certain. So today I moved a portion of my planned 2010 conversion and I’ll wait and see what the next six months brings before I move the rest.

The next post will address the mechanics of Roth IRA conversion.

Link to Other topics in the Special Report: Converting to a Roth IRA