Written by Jeremy Biberdorf

You cannot fail to have heard about the issues with volatility that have been plaguing the markets since October. Many investors have seen the value of their investments flounder in the chaos. However, there may be one bright star on the horizon. It’s possible to make sure that you have access to decent tax free savings on your retirement, by taking advantage of your drop in investment value today.

You can do this simply by converting from a traditional IRA to a Roth IRA. Yes, you will have to pay tax on the amount you invest on the changeover, but the amount you pay is likely to be low if the value of your investments has been seriously reduced. You take advantage of the low amount of tax payable today, due to market volatility and reduction in investment value, and you get access to funds in retirement that have been subject to tax free growth.

The difference between an IRA and a Roth IRA

If you do not completely understand the difference between an IRA and a Roth IRA, you may be wondering why you should take note of this particular piece of retirement financial advice. In simple terms the difference is this:

  • If you choose to invest in an IRA, the money you invest is not subject to taxation now but it is taxable when it’s withdrawn after you retire. This makes an IRA a popular choice for people in a high income bracket.
  • If you choose to invest in a Roth IRA, the money you invest is subject to tax now but then has tax free growth and is not subject to tax on withdrawal. This is what makes it an appealing option if you have current investments in a traditional IRA which have lost their value

Converting to a Roth IRA – should you do it?

So, is converting to a Roth IRA really a good idea? The answer could be yes, if you are unlikely to be subject to a high rate of tax when you switch. Its one of the few advantages you could potentially get from the current market uncertainty.

Conversion could also be a good idea when you retire. This Roth IRA conversion ladder means that you can invest in a traditional IRA while your earnings are high, then convert once you have reduced earnings, at which point the taxation level is not high.

The same applies to a Roth 401 (k) savings plan. If your employer allows you access to this type of plan, you can choose to pay tax upfront as opposed to the tax free investment option provided by the traditional 401 (k) plan. It’s worth noting that any contribution match your employer makes will be held in a traditional 401 (k) plan, but you will only receive one overall statement.

Benefits of a Roth IRA you may not have considered

Aside from taking advantage of the recent market volatility, there are other advantages to a Roth IRA that you may not have considered. You can:

  • Create an emergency fund.
  • Put money aside for the deposit on a home.
  • Invest to pay for your children’s college education.
  • Invest so that your heirs can have a tax free inheritance.

However, you do need to be careful when choosing a Roth IRA as there are mistakes that you can make. These mistakes usually revolve around restrictions that are in place. For instance, if you withdraw from the IRA before the age of 59 and a half, or less than five years after you invested, you could be subject to taxation and penalties. This depends on the circumstances surrounding the withdrawal, so you need to do your research.

It’s important to find the answers to all your questions before you make the final decision about choosing a Roth IRA.