Roths During a Correction
Freddie: With market turbulence, it's crucial to ask, are we in a short-term dip or a prolonged downturn? The timing of a Roth conversion can really impact your taxes and long-term financial security. In today's episode, we'll break down how to spot the difference and why a downturn might be the right opportunity, the perfect opportunity to make a smart financial move.
Hello again everyone, and welcome to this episode of Leibel on Fire. I'm Freddie Bell. And joining me as always is Amazon's bestselling author of two incredible books, the first one, Living with Financial Anxiety, and he's also the author of Authenticity. Hello Leibel Sternbach and welcome back.
Leibel: Hey, how we doing today?
Freddie: Unbelievable. And today let's talk about Roth conversions during a correction. So let's kick it off, if you don't mind. Leibel, can you tell us why retirees should consider a Roth conversion during a market correction? And most importantly, what is a market correction?
Leibel: Let's start with a Roth with what a correction is, and then we'll talk about a Roth conversion.
And why this is the best opportunity to do it. So. A market correction. The technical term is when the market pulls back 10% or more from a recent high. So when they, whatever the recent high was, if it declines by 10% or more, that is considered to be a correction. Nowadays you've got a lot of TikTok influencers who are redefining this term market correction, and they're deciding that a 3% pullback is a correction or a 5% pullback.
But the old school definitions are 10% is a correction and 20% is a bear market. The reason why that is important, right? And that these terminologies actually have some meaning other than we lost money at least in paper is the statistical probability of these events, right? Because if an event is frequent.
If it happens frequently, then it isn't statistically important, right? It's gonna come back. You don't have to worry about missing this opportunity. If an event isn't so frequent, then you wanna make sure to take advantage of it when it comes back. And so when we talk about a correction. A correction being a 10% decline or more in the market.
That is something that's statistically in the long view happens with the frequency of about every 18 months. Right? So if it comes back, if it comes around every year and a half. That means that you want to take advantage of that opportunity when it happens, right? And so that becomes really important when we're talking about doing Roth conversions, right?
And so Roth conversions, right? Your question was, should we do Roth conversions? Why should we consider doing a Roth conversion in a correction and fundamentally. We do Roth conversions because we're trying to save money on taxes, right? We're playing an arbitrage game where we think the pricing of something today is cheaper than the pricing of something tomorrow, or more expensive than the pricing tomorrow, right?
We're taking advantage of a discrepancy in price. The common way of doing this is, you buy something in New York and you sell it in Chicago at a different price, and you could do that all day long if the price discrepancy was big enough right to profit on it.
Which interestingly enough, if you've seen the headlines, bankers are now flying gold from London to New York because of these tariffs that apparently the price of gold has such a discrepancy that it's worth flying gold from London to sell it in New York. Amazing. But these opportunities happen, right?
This discrepancy in price. And when we look at taxes, there's often a discrepancy between what we'll pay in taxes this year versus next year, or 10 years or 20 years down in the future. And so what we're constantly looking for is how can we take advantage of that discrepancy, right? Will we be in a lower tax bracket in the future or a higher tax bracket in the future?
And if we find ourselves in a lower tax bracket, then we want to take advantage of it, right? Or if we think that our assets are gonna grow to such a high level that we're gonna pay more taxes on it in the future, then it makes sense. Let's pay taxes now 'cause it'll be a smaller nut to pay now than in the future.
Freddie: That makes a lot of sense. So, what does this have to do with a Roth conversion?
Leibel: So the question becomes right with a Roth conversion, we want to pay the least amount of taxes possible. And so the whole buy the dip is you're buying it at a discount, right? It's a discount. You're getting a 20% discount, 10% discount on your stock, which you know, makes sense
only if you plan on holding it for the long haul. Only if you have a long time horizon. Only if you think the market's gonna go up. Which generally, statistically speaking, those things will happen. But the real question with a Roth conversion is, well, we're getting a discount on taxes. Forget about the market, right?
If we have a, million dollars in our IRA account and we have a 10% correction, that's a hundred thousand dollars that was wiped out from IIRA account right now. That is a huge, burden. Right? It's a hundred thousand dollars that's gone, that was a hundred thousand dollars that could have turned into $5,000 a year of income.
Right? That's a scary thought. And oftentimes we get so focused on that thought that we forget about, well, what is the opportunity here? How do we make lemonade out of these lemons that life has handed us? And the answer is, you do Roth conversions. If you were gonna do a Roth conversion anyways, you now get to do it at a 10% discount, right?
So you get to save, if you were gonna convert that a hundred thousand dollars anyways, you can convert it at a smaller amount, pay less taxes, and then next week, next month, next year, when the market recovers, you have effectively saved 10%, 20%, whatever it is on your Roth conversion, which is an amazing deal, right?
So you get to take advantage of this opportunity that life is giving you. Obviously, it's gotta make sense.
Freddie: It does, and we're talking about Roth conversions during a correction, and it seems as if, and I'm following pretty closely that you're talking about really all the advantages of doing a Roth conversion during a correction.
But what about the risk or the downside of doing a conversion like this while a correction is happening?
Leibel: So that is a great question. Right? There is always a downside to everything, right? Nothing is risk free. There is always a risk. And the question is can you quantify what that risk is?
And oftentimes, if a person can't quantify to you what the risk is, it just means that they don't understand what the risk is, right? We might think that, oh, well it has no risk. No, it has a risk. It's just very difficult to quantify what the risk is, or we don't know what they are. So let's talk about the risks associated with doing a Roth conversion during a correction.
The biggest risk and the biggest mistake that I see people making is. When you do a Roth conversion, the normal process that most people do is they sell their assets in their IRA account. They transfer the cash into their Roth account and they've converted it now, and then they purchase whatever they're gonna purchase.
The problem is you have this timing issue, right? The market is extremely volatile. We're trying to take advantage of that volatility. What happens if during the time that you sold and you're waiting in cash, the market recovers? What if that's the day that the market recovers and bounce back 5%? Right?
What if, Trump gets on TV and announces that he's now going to, be paying China to send us goods, and all of a sudden the market goes crazy and they're like, oh, and the market goes up. What happens, right? What if we don't know, right? And we're trying to time something and what they say about time the market, right?
That most people shouldn't time the market. Most people can't time the market. And so when it comes to a Roth conversion, the thing that I try to do for people, and it's very difficult to do this as a retail investor on the retail platform, where you're directing your own trades. As an advisor, I can do this.
But there aren't a lot on, like the Fidelity and the Schwab platforms that make this easy for a regular person to do this. But what we do is we convert the positions, right? If it's the S & P 500 that we're converting or whatever it is that we're converting, we're going to transfer that security from your IRA account to your Roth account.
And by transferring that security, we haven't changed ownership, right? So market recovers while we're in middle of doing that transfer. We participate in that, we don't have this risk of missing out on that gains. Now the downside of that is that we have the potential that at the point of transfer, the market recovers and now we don't get as much value from that Roth conversion or we accidentally converted more than we were expecting.
But you gotta weigh your risk and decide which one is more important to you, and then hedge accordingly when you take your actions.
Freddie: It's interesting, we're talking about Roth conversions during a correction, and it seemed pretty straightforward to me when we started this conversation.
So here I am. I'm Johnny Lunchbucket retiree, and how can I forecast the tax implications of doing a Roth conversion and make sure that I'm doing it during the right time?
Leibel: So. The answer I'm gonna give you is the same answer that you need to use for any trade you make. Right? Okay. What do professional traders do before they make a trade?
They go in knowing exactly what their possible outcomes are. They know what the upside potential is. They know what the downside potential is. They know what is going to make them exit their position, right? Why are they doing this trade? So when we do a Roth conversion, you gotta have those answers. You gotta know, well, if I convert $10,000, I'm gonna convert $10,000 and I'm doing it because I'm gonna pay on that.
Let's say $2,500 in taxes. And I'm doing it because I know I'm gonna be invested for the next 15 years. I know the market on average returns, 10% or 8%, whatever number you decide to use. And I know that in 15 years from now, my estimated taxes are gonna be higher. And again, you did it because you did the math and you know that your taxes are gonna be higher if you just
think it's gonna be higher. That's not really a good reason to do it. But you did the math and you're like, I'm gonna be in a higher tax bracket where I'm gonna have more money to pay taxes on. So I'd rather pay taxes on the seed than pay it later, and it's gonna be worthwhile in taxes. And I know in theory, I'm gonna save a thousand dollars in taxes or $10,000 in taxes, whatever that number is, and it's enough money that it's worth, it is worth risking the uncertainty of the future on.
Freddie: That's a good answer and I'm curious now, so, let's take it a little further. So now I'm 73 and I'm taking the required minimum distribution, the RMD. How does that factor into all of this? With the Roth conversion Leibel?
Leibel: So the main reason to do Roth conversions is because our retirement accounts, and we'd like to think that they belong to ourselves, right?
And that we control them. And one of the biggest myths that we have in this country is that we control how much income we have in retirement. We don't, the federal government likes to dictate that as much as possible. But the idea is that the federal government, one of the levers that they have, that they get to control the flow of our money to our wallets that we then use to spend on goods and services, which, I guess it makes sense from an economic standpoint that the federal government wants to control the flow of the economy, but
they don't really care about us as individuals and so what happens in retirement, they attach a little spigot to our retirement account and they say they control just how fast we have to take money out. And so starting at age 73 or 75, depending on when you were born, you're gonna have to start taking these required minimum distributions.
These required minimum distributions, start at a reasonable amount. It started at about 4% a year, and you're like, well, I'm planning on taking 4% anyways to live on. Off of, or maybe I was planning on taking five or six or 7%, like, it's okay, they're not making me take more than I would need. But then all of a sudden what happens is we hit our eighties and between 80 and 90 that skyrockets and by the time we're 90, right?
If we're lucky enough to live to 90, we're taking almost 25% of our account value out and the RMD table can be changed at any time. Congress can just come along tomorrow and say, you know what? We're accelerating this. We need more tax dollars. We want to stimulate the economy more. We're going to require people to take out, 10% a year, right?
And all of a sudden our stuff is drained. So required minimum distributions, is that little spigot that the government controls, how much and how fast we spend our retirement dollars. Roth conversions fundamentally take that control back because we take it out of an account that the government controls.
We say, we're gonna pay our pound of flesh today because we know what that pound of flesh is gonna be. In exchange for paying that pound of flesh, we now get to grow this money tax free for the rest of our life. We get to take that money out tax free because we already pay taxes on it.
The only caveat is that whoever inherits that money, as long as it's not our spouse, and they're not more than 10 years younger than us, they have to take it out within 10 years. And so that becomes a tricky thing, which I'm on record, in saying Congress is being shortsighted and greedy but you can't solve all the problems.
Freddie: Not all of them.
And if you do have questions about our discussion today, you can go to Yields4U.Com. That's yields, the number 4, the letter U dot com. And Leibel, we gotta leave it right there. Today we explored how market corrections can create unique opportunities for Roth conversions and how to time them strategically.
Navigating market volatility can be challenging, but with the right approach. You can turn uncertainty into wonderful opportunity. Until next time, stay informed, stay proactive, and keep building a strong financial future.
