The market pull back that many experts predicted would happen last year finally came in 2015, leaving many investment and retirement portfolios with much lower balances. If your income and retirement plan portfolios declined this year, then this could be a good opportunity to move some money around. Now could be the time to convert some or all of your traditional IRAs or qualified plans to Roth accounts. This simple strategy can help you to weave a silver lining from an otherwise financially mediocre year.

How it Works

Roth conversions have become much simpler to accomplish since Congress lifted the aggregate income restriction for this procedure in 2010. This means that taxpayers can now convert a traditional or Roth IRA of any size in a given year without regard to the amount of income that is generated. However, that does not mean that it’s always wise to convert traditional plan or account balances at once, or right away. If your income will decline in the future, then it’s probably better to wait until then to do the conversion so that you might be in a lower tax bracket. (For more, see: Pros and Cons of Creating a Backdoor Roth IRA.)

But if your income was substantially lower this year due to job loss or other circumstances, then now could be the ideal time to generate some additional taxable income. This can be a wise move if it looks like you are going to have credits or deductions that will otherwise go unused.

For example, if you are married with two kids and your normal annual income is about $60,000 and you lost your job in February and have been collecting unemployment benefits for six months, then you will probably come out ahead by converting that $30,000 traditional IRA that you rolled over from your last job. If you do that, then you will not likely pay much in the way of income tax on the conversion, even though it is a taxable event. If your total income from the conversion, the two months you worked and your unemployment benefits total $50,000, then you’ll be able to cut that number at least in half when you do your taxes, as you can subtract two personal and two dependent exemptions, a standard deduction (or more if you itemize) and then two child tax credits if both of your dependents are under age 17.

Some of these deductions and credits would definitely go unused if not for the conversion, because your income would be too low without it to need them all. Since you can’t carry the unused amounts forward, it makes sense to do something that generates taxable income now so that you can take advantage of them.

Beware Tax Brackets

However, it is also necessary to see how this can affect your tax bracket. If your circumstances are as listed above, but you have $200,000 in a traditional 401(k) that you left with a previous employer, then it would obviously not make sense to convert all of that in one year, because it would put you in a higher tax bracket that would then reduce your plan balance unnecessarily.

You would instead want to convert the portion for this year that would be tax free due to your deductions and credits as shown previously and then convert the remainder over the next one, two or perhaps three years or you could wait until you have another bad year and convert another chunk of it at that time. There is no absolute right or best way to do it, but some years will be better than others. Bear markets are always good times for conversions, as the taxable balance of your conversion will probably be less than it was when stocks were high. (For more, see: How to Convert a Non-Deductible IRA into a Roth IRA.)

It can be challenging in some cases to determine whether your conversion will put you into a higher tax bracket, but if you end up going a few dollars over, this will not make much of a difference because only the amount that creeps into the next higher bracket will be taxed at that higher rate. This is one of the advantages that comes with a graduated tax structure.

The Bottom Line

Converting some or all of your traditional IRAs or qualified plan balances can help you to capitalize on your reduced income or market losses in a given year. If you are able to use the deductions and credits that would otherwise go unused, then you will save money on taxes both now and in the future. A traditional retirement plan balance that is converted into a tax-free balance will be worth much more to you tomorrow than it would otherwise, and this freedom from taxation will also simplify your retirement plan in many respects. For more information on how you can profit from converting your traditional retirement savings to Roth accounts, consult your financial advisor. (For more, see: Top Strategies for Tax-Free Roth IRA Conversions.)