First, there was the supply chain slowdown, then the inflation ramp-up, followed by the gas price explosion, and now, we’re staring down the real risk of recession. It probably should come as no surprise that this barrage of economic body blows finally tamed America’s long-running bull market.
If we are, indeed, nearing a recession, certainly some investors will be in better position to weather it than others. But for anyone, the sight of a retirement account dropping by thousands or the value of a business plummeting over a short period is painful. A market downturn is not necessarily devoid of upside, though.
This isn’t to highlight that old, tired cliché about turning a crisis into an opportunity — we’d all prefer to not have to deal with the crisis. Rather, it’s about being proactive, rather than just standing pat and riding out the trouble until the economy inevitably rebounds.
These are just a pair of simple, yet effective, strategies:
Investors: Consider Roth IRA ConversionsWhen the market sinks and the economy enters a period of decline, one of the most visible impacts will be in investors’ IRAs. Years of contributions and steady growth can evaporate (for the moment), but you can also make some significant tax savings, depending on the type of IRA you have.
Withdrawals from a traditional IRA are taxed as income, which can make for an unwelcome expense during retirement. A Roth IRA, however, has tax-free withdrawals and growth — with a drawback being that contributions are not tax-deductible. So, converting a traditional IRA that has lost value during a downturn to a Roth IRA will come with an immediate tax hit but will most likely lead to future savings that offset that cost.
For example, if you have a traditional IRA worth $100,000 that drops to $75,000 and decide to convert it to a Roth IRA, you might pay around $15,000 in taxes on your upcoming return. But let’s say five years later, the market may rebound, you’re ready to retire and your Roth IRA is now worth $200,000. Once you begin taking withdrawals from that account, the cumulative tax savings could be more than that $15,000.
As long as you expect to make up the immediate tax cost, a market downturn is an ideal time to make a Roth IRA conversion.
Business Owners: Focus on the FutureThere is never a bad time to focus on estate planning, but there are special considerations a business owner can make during a recession. Notably, business transfers made to children or trusts have tax-affecting valuations associated with them, making a downturn with the potential to decrease the value of your business an opportune time to make those transfers.
Say you want to transfer 40% of your business to the next generation of owners, but the value of the business has dropped from $5 million to $3 million over a year. If you make the transfer while the business is worth less, you’ll be using less of the estate tax exemption, proportionally. If you wait to do the transfer, should the economy improve and the business make up the lost value or surpass it, you would have to use more of the exemption to transfer 40%.
As with Roth IRA conversions, it comes down to timing — and a recession, believe or not, is the right time for many wealth-building strategies.
The Days AheadWe can’t guarantee the economy is headed to a recession or how severe it would be if it does occur in the months to come. Expert opinions vary, and despite all the recent turmoil, current conditions are different from the recession of 2020, which was largely created by systemic issues.
As with all of these strategies, you should always consult your own tax and/or legal adviser.
Ultimately, individual investors, business owners and wealth advisers like myself can’t change what the economy will do, but we can implement strategies that withstand the worst of times and position us well for the better days to come.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Matthew Helfrich, CFPPartner and President, Waldron Private Wealth
Matt Helfrich is President of Waldron Private Wealth, a boutique wealth management firm located just outside Pittsburgh, Pa. He leads Waldron’s strategic vision, brand and value proposition and overall culture of the firm. Since 2002, Helfrich has served in a number of roles including: Chief Investment Strategist and Chief Investment Officer, where he was instrumental in creating and refining Waldron’s investment discipline.