The silver lining of a cloud is not actual silver, but is actually sunlight diffracted by cloud droplets on the periphery. The darker and denser the cloud, the more prominent the silver lining appears to be. Hence the metaphor.
So when we talk about silver linings in a down economy, we do so with the knowledge there is, in fact, light behind the cloud. When we invest, we do so knowing that the fundamentals of our economy are sound. With this knowledge, we can use both the clouds and the linings to our advantage.
Silver Lining No. 1: Roth Conversions
The coronavirus caused a major market downturn and probably took your retirement account balances with it. For those who have a traditional IRA, you have likely seen years of gains offset by this recent period of loss. That’s the cloud. But we know there’s light. Historically, markets have bounced back from even the worst economic plights.
So let’s take advantage of the cloud and perhaps consider a Roth IRA conversion. When converting a traditional IRA to a Roth IRA, you pay income taxes on the pretax funds you are converting. This can move you into a higher income tax bracket, reduce deductions and credits, and impact Social Security benefits as well as Medicare premiums. That’s a cloud in and of itself.
Of course, there tends to be very good reasons to do a Roth IRA. The silver lining is the benefit of being able to take tax-free distributions, even on earnings from your investments. This was already a pretty good time to do a Roth conversion, as tax reform eliminated AMT considerations for most people and lowered tax rates on the conversions themselves. Those tax rates are set to expire at the end of 2025, so the window is closing.
While it certainly doesn’t feel great to see your IRA account balance go south, doing a Roth conversion when markets are down provides additional savings. Your tax bill is based on the value of the IRA account at the time of conversion. This is one of those rare instances where it makes perfect sense to “time the markets.” When the market rebounds (the light behind the cloud) those earnings from the funds you converted into your Roth will be tax free.
- If you have seen a change in income as a result of the coronavirus, the cloud is darker, but the opportunity is brighter. Taking your Roth conversion when your income is lower means you could potentially pay taxes in a lower bracket, and potentially have more losses to offset your gains.
There are, of course, several considerations before opting to do a Roth conversion. If, as might be the case in these troubled times, you need your IRA money for living expenses, now might not be the best timing for a conversion. If you anticipate being at the phase-out threshold for emergency relief as part of the CARES Act, that might also give you pause.
It’s worth noting that you don’t have to take the entirety of your Roth conversion right away. You can do one portion now and one portion later. Market volatility will likely be with us, at least in the short term, so there are likely to be opportunities to benefit from market timing down the road.
Silver Lining No. 2: Tax Deadline Relief
If procrastinating is your jam, you got a nice big silver lining from the IRS in the form of a tax deadline filing extension. The deadline for federal taxes has been moved back to July 15, 2020, for individuals, gifts, estates, trusts, corporations, foundations and partnerships.
But beyond giving you more time to prepare, there are some potential economic benefits. The IRS is also moving back the second-quarter estimated tax payment deadline (which is normally June 15, 2020), which means both Q1 and Q2 estimated tax payments are now due July 15, 2020. This applies to individuals, trusts and corporations.
The July 15 extension also applies to the IRA and HSA contribution deadline for 2019 contributions. If your circumstances have changed, and a move to lower your tax bill from 2019 now makes sense, this is an opportunity you should consider, if you have not reached the contribution limit (for IRAs, it’s $6,000, or $7,000 for those 50 or older; for HSAs, it’s $3,550 for individuals and $7,100 for family coverage).
It’s also worth noting that the change in deadline only applies to federal tax returns. While almost all states have additionally passed their own 2019 filing relief, note that it’s not always the same July 15, 2020 date. A few are sooner, so make sure you understand your exact filing deadline. Additionally, many states have not completely aligned with the federal deferral on 2020 estimated tax payments.
Understanding these estimated tax dates is especially important if you typically rely upon tax withholding from Required Minimum Distributions. Since the CARES Act waives the need to make 2020 RMDs, it won’t be necessary to take the RMD and the resulting tax withholding. But the government will still want to collect tax, so making estimated tax payments may be a new process this year in lieu of the RMD tax withholding.
Silver Lining No. 3: Stuff is Cheaper
The markets are looking awfully cloudy these days. It appears that investors are pricing the impact of COVID-19, and the short-term outlook isn’t great.
On the other hand, stocks are on sale! While you shouldn’t attempt to time the markets, now might be a good opportunity to rebalance your portfolio. Portfolio rebalancing is all about selling off assets that went up, and buying assets that went down. It’s well worth checking in with your adviser to see how your portfolio looks in light of your investment goals.
- Investments aside, big-ticket items are available at a discount right now. If you need a new car soon (even if you can’t drive it regularly) and are reasonably secure in your income, now would be an advantageous time to look into one. At a minimum, know that you are negotiating from a position of strength when it comes to price. Don’t be afraid to walk away, and not just for social distancing reasons.
As you have probably heard, mortgage rates are near all-time lows. Perhaps you have dismissed the idea of refinancing based on the conventional wisdom that you should only refinance if you can reduce your rate by 1% or more.
This might be a mistake. First of all, let’s look at the simple math. If the amount you can expect to save in monthly payments in the short term will cover closing costs, it’s probably a good decision to refinance, regardless of rate. Further, if you have private mortgage insurance, and your house has appreciated, you may be able to reduce or eliminate that component of your mortgage payment.
If your house has appreciated in value, it might be worth cashing out and using the money to pay down bad debt, such as credit card debt. Otherwise, you can use the lower monthly payment to put money aside for an even rainier day.
Time for a Gut Check
Before reaching for the silver lining, it’s important to ask yourself a few questions:
- Can I afford a Roth conversion? While the economy is in rough shape and markets are volatile, paying off Uncle Sam may be just the right counterpunch.
- Are my financial circumstances likely to change in the short term? You don’t want to make a major decision if the assumptions behind them could fall underneath you.
- Am I investing enough to meet my retirement goals? Anytime the markets are down, it’s a good time to look at your portfolio and make sure you are setting enough aside for the retirement you want.
Written by Brian Vnak, Vice President, Wealth Enhancement Group, advising clients on income, gift, trust and estate tax issues. Mr. Vnak is a Certified Financial Planner™ and Certified Public Accountant (CPA) who graduated Magna Cum Laude from the University of Notre Dame with two degrees: a Bachelor of Business Administration and a Master of Science in Accountancy.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax adviser.
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