Is it better to wait for a market downturn to do a Roth conversion?

Question

Based on this article from Fidelity, it appears that the tax basis for a Roth conversion is the net value of the retirement account at the time of the conversion.

As such, let's say I have a traditional IRA worth $10k prior to a market downturn, for which my tax basis would have been $7k. If I had invested in a Roth account initially, I would have paid taxes on the $7k I invested.

Now let's say the market declines, and my portfolio hits a value of $5k (quite possible with my risk tolerance). If I convert at this stage, I would only pay taxes on $5k. Sure, in a 25% bracket that is only $500, so nothing terribly outstanding, but the question scales, and I just picked convenient numbers.

Taking advantage of this doesn't require predicting a market downturn, which is another topic entirely. Instead, it only requires that we expect that market downturns will occur.

Because of increased regulations in the US recently, it appears that we are seeing less large scale volatility. While markets still rise and fall, some protections ensure that events like the late '90s tech bubble or the '08 housing crisis don't have the same impact on the markets.

So, I wonder whether it's better or not to wait for a possible market downturn to perform a Roth conversion.

Answer 1

On average, the market will be down 1 year out of 4. 26 of the last 100 years on the S&P were negative. The Roth conversion offers a unique opportunity to convert early in the year, and decide at tax time next year whether you are happy with the result. Of course, if your fund or stock is up, you are likely better off, paying the $1250 tax on the $5000 conversion that's now worth $6000 or more. If it's down, you can recharacterize. The volatility of the market helps makes this process more attractive. If my converted shares dropped quite a bit, the recharacterization is far more desirable than a small drop or no drop at all. Of course we don't wish for that drop, any more than we wish for our house to burn down to make our insurance pay off.

To be clear, you'll benefit from a conversion she the market goes up. The downturn only lets you reverse the bad move.