First there was the slowdown in the supply chain, then the ramping up of inflation, followed by the explosion in the price of gasoline, and now we are looking at the real risk of recession. It should probably come as no surprise that this barrage of economic body blows has finally tamed the long-running US bull market.
If we are indeed approaching a recession, some investors will certainly be in a better position than others to weather it. But for anyone, the sight of a retirement account dropping by the thousands or the value of a business plummeting in a short period of time is painful. However, a market downturn is not necessarily devoid of benefits.
This is not to highlight that tired old cliché of turning a crisis into an opportunity – we would all rather not have to deal with the crisis. It’s more about being proactive, rather than just standing still and avoiding trouble until the economy inevitably rebounds.
These are just two simple, yet effective strategies:
Investors: Consider Roth IRA Conversions
When the market crashes 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 now), but you can also see significant tax savings, depending on the type of IRA you have.
Withdrawals from a traditional IRA are taxed as income, which can be an undesirable expense during retirement. A Roth IRA, however, has tax-free withdrawals and growth — with a downside being that contributions aren’t tax-deductible. So, converting a traditional IRA that lost value during a downturn to a Roth IRA will have an immediate tax impact, but will most likely result in future savings that offset that cost.
For example, if you have a traditional IRA worth $100,000 that drops to $75,000 and you decide to convert it to a Roth IRA, you could pay around $15,000 in taxes on your next return. But let’s say five years later, the market can rebound, you’re ready to retire, and your Roth IRA is now worth $200,000. Once you start making withdrawals from this account, the cumulative tax savings could exceed that $15,000.
As long as you expect to offset the immediate tax cost, a market downturn is a great time to make a Roth IRA conversion.
Business owners: Focus on the future
There’s never a bad time to focus on estate planning, but there are some special considerations a business owner can make during a recession. Notably, business transfers made to children or trusts are associated with valuations with tax implications, making a downturn that may decrease the value of your business an opportune time to make these transfers.
Say you want to transfer 40% of your business to the next generation of owners, but the value of the business has gone from $5 million to $3 million in one year. If you transfer when the business is worth less, you will use less of the inheritance tax exemption, proportionally. If you wait to transfer, if the economy improves and the company catches up or exceeds the lost value, you will need to use more of the exemption to transfer 40%.
As with Roth IRA conversions, it’s all about timing — and a recession, believe it or not, is the right time for many wealth-building strategies.
The coming days
We cannot guarantee that the economy is headed for a recession or how severe it would be if one were to occur in the coming months. Expert opinions vary, and despite all the recent turmoil, current conditions are different from the 2020 recession, which was largely created by systemic issues.
As with all of these strategies, you should always consult your own tax and/or legal advisor.
Ultimately, individual investors, business owners and wealth advisors like me can’t change what the economy will do, but we can implement strategies that weather the worst of times and position us well for better days to come.
Partner and President, Waldron Private Wealth
Matt Helfrich is president of Waldron Private Wealth, a wealth management firm located just outside of Pittsburgh, Pennsylvania. He leads Waldron’s strategic vision, brand and value proposition, and overall company culture. Since 2002, Helfrich has held a number of positions including Chief Investment Strategist and Chief Investment Officer, where he was instrumental in creating and refining Waldron’s investment discipline.