Bad times for stocks are good times for Roth IRA conversions

Q: Are the taxes due upon conversion of a traditional IRA to a Roth IRA measured based upon the prior year-end value of the traditional IRA or its value on the date of conversion to a Roth IRA? — John Flood, Bradenton, Fla.

A: Your taxable income from a conversion is based on the actual amount that is transferred out of your traditional IRA into the Roth IRA, according to Don James, a tax and financial planning partner at Kiplinger & Co. in Strongsville, Ohio.

He gave this example: Suppose the value of your traditional IRA was $10,000 on Dec. 31, 2015, and is now valued at $8,000. If you transfer the $8,000 into a Roth, you are taxed on the $8,000, not the $10,000 it was worth at year's end.

When the stock market is down, it's “a great time to consider a Roth conversion,” says James.  “When the market rebounds, all the growth is in your Roth IRA, which is never taxed as long as you follow the Roth IRA distribution rules.”

Typically, James recommends that you convert only enough to use up the remainder of your existing tax bracket. “Don't let the conversion push a portion of your income into a higher bracket,” he says. “The nice thing is you have until Oct. 15 of the year following the conversion to change your mind.”

That’s right, James says you can undo the conversion (it’s called a “recharacterization”) simply by transferring the amount in your Roth IRA back to your traditional IRA.  If you are uncertain about your current year's income, you can convert your traditional IRA into multiple Roth IRAs and recharacterize one (or more) to prevent pushing your income into a higher bracket, says James.

Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Emailrpowell@allthingsretirement.com.