All that red ink flowing from Wall Street doesn't look pretty. But it may be just the signal Americans need to take another look at converting their traditional IRAs into Roth IRAs.
"It might be a very good time to convert now," says Nicholas Kaster, author of "Saving for the Future: Roth and Traditional IRAs" and senior pension-law analyst for CCH Incorporated, a Riverwoods, Ill., provider of business and tax-law information.
"It's an especially good time to run the numbers," adds Clif Helbert, principal responsible for retirement-plan marketing at Edward Jones Investments, based in St, Louis. "If you had an IRA worth $100,000 that, because of market conditions, is worth $80,000, the tax bite is much less" for a conversion.
To understand the advantages, consider the hapless hypothetical investor Mike Morse. Two years ago, he converted his $100,000 traditional IRA into a Roth because he liked its long-term tax advantages. Although it doesn't defer taxes the way a traditional IRA does, a Roth allows retirees to pull out their money tax free, no matter how much the account has grown.
So Mr. Morse converted his $100,000 IRA, which cost him $27,000 in extra taxes. (In the 27 percent tax bracket, he owed the government for the tax deferments he'd earned when he originally invested in the traditional IRA.) Then Wall Street crashed, reducing his investment to $80,000. His IRA move proved to be a negative double-whammy.
But if Morse had waited until this year to convert, he might well have positioned himself for an impressive rebound. To begin with, his tax would total only $21,600 - a $5,400 savings, thanks to the account's lower value. And if the account doubles in value by the time he retires, Morse would reap $160,000 tax free. (With a traditional IRA, he'd owe tax when he withdrew that amount.)
Of course, timing such conversions always involves risk. The stock market may fall again, making future IRA conversions even cheaper.
"It's like buying a stock," says Jackie Perlman, senior tax-research analyst at H&R Block, based in Kansas City, Mo. "You want to try to buy as low as possible, but who can say what that best time is? The bottom line is: You should always talk it over with a good financial professional."
Even if the market timing is right, a Roth doesn't make sense for everybody, investment professionals warn. For example, you can't convert if your adjusted gross income exceeds $100,000. Also, if you expect to fall into a lower tax bracket at retirement, a traditional IRA might make more sense.
Then there's your investment horizon. The closer you are to pulling out the money, the less tax advantage the Roth offers.
"If you're a young person converting a small amount ... the odds are very favorable that you should convert," says Mr. Kaster of CCH. But if you're "someone who's 53 years old with $800,000 in the IRA, well, I'm not sure you want to take that kind of a tax hit at that age."
Tax law does offer IRA investors one escape hatch. If they convert to a Roth IRA and the market really goes sour, investors can "recharacterize" it back to a traditional IRA. Investment professionals such as Mr. Helbert of Edward Jones don't recommend the procedure.
And tax experts point out that it's limited to once a year (with a 31-day delay period for year-end conversions). Also, investors have to recharacterize their IRAs by the due date of their tax return. "You can play, but you can't play too much," says Ms. Perlman of H&R Block.
Still, recharacterization may offer tentative IRA investors the fallback position they need in order to make big forward moves in a volatile market.