When the stock market drops 20% or more, the internet lights up with advice to convert your traditional IRA to a Roth IRA. The logic seems bulletproof: your account is worth less, so you pay taxes on a lower balance. Later, when the market recovers, all that growth is tax-free. It sounds like a free lunch. But in practice, a poorly timed Roth conversion can lock in losses, trigger surprise tax bills, and even reduce your lifetime net worth. The culprit? A concept called sequence-of-returns risk—usually discussed in retirement withdrawal planning but equally dangerous when converting assets. This article explains the math, the edge cases, and the practical steps to avoid turning a smart tax move into a costly mistake.
A Roth conversion moves pre-tax retirement funds into a post-tax Roth IRA. You owe income tax on the converted amount in the year you convert. If your traditional IRA holds $100,000 and the market crashes 30%, dropping it to $70,000, converting at $70,000 means you pay tax on $70,000 instead of $100,000. Assuming a 24% federal tax bracket, that’s $16,800 in tax instead of $24,000—a saving of $7,200 upfront.
The catch is that you must pay that tax from outside the IRA—preferably from a taxable brokerage account or cash. If you use IRA funds to pay the tax, the portion withdrawn for taxes is treated as an early distribution, subject to ordinary income tax plus a 10% penalty if you’re under 59½. That erases much of the benefit.
Even if funded externally, the conversion only works if the market eventually recovers. If you convert at $70,000 and the market recovers to $100,000, your Roth now holds $100,000 with zero future tax liability. That’s the ideal outcome. But if the market drops further to $50,000 before you can benefit, you’ve paid tax on $70,000 for an account now worth $50,000—a net loss of tax efficiency.
Sequence-of-returns risk normally refers to the danger of withdrawing money during a downturn early in retirement. In a Roth conversion, the risk is inverted: you’re adding tax liability at a low point, but the account’s subsequent growth may not outpace the tax cost if the recovery is slow or uneven.
Consider a real-world scenario: In March 2020, the S&P 500 fell 34% in five weeks. An investor with a $200,000 traditional IRA saw it shrink to $132,000. Converting at that trough would trigger tax on $132,000. By August 2020, the market had fully recovered, and the IRA was back above $200,000. The converted Roth would now hold $200,000+ tax-free—a huge win.
But now consider 2022: The S&P 500 fell 25% from peak to trough in October 2022. An investor who converted in October 2022 at the bottom paid tax on $150,000 of a formerly $200,000 account. However, the recovery was uneven: the S&P 500 didn’t regain its all-time high until January 2024—15 months later. During that period, the investor could not access the converted funds without penalty (five-year rule applies for earnings in Roth). Meanwhile, the tax bill came due in April 2023. If the investor had to sell taxable investments to pay that tax at a loss, the effective cost rose further.
Roth conversions come with a five-year aging period per conversion. If you withdraw converted principal before five years, you face a 10% penalty on the conversion amount (not just earnings). For a down-market conversion, you might need those funds sooner—if you lose your job or face a medical emergency. Locking funds into a Roth for five years during market volatility adds rigidity.
A conversion of $70,000 from a $70,000 IRA seems straightforward. But if you earn $80,000 in regular income and are married filing jointly, your taxable income jumps to $150,000—pushing you from the 12% bracket straight into the 22% bracket (2025 thresholds). The effective tax rate on the conversion could be 22% or higher, not the 12% you expected. The spread between brackets can turn a 12% conversion into a 22% conversion, costing $7,000 more on a $70,000 conversion.
Instead of relying on hope, run the numbers with a break-even analysis. The break-even growth rate is the percentage the account must gain after conversion to make the tax paid worthwhile compared to leaving the money in the traditional IRA and paying tax on withdrawals later.
For example, assume $70,000 converted at a 24% tax rate ($16,800 tax paid externally). Without conversion, the $70,000 stays in a traditional IRA and grows 8% annually for 10 years to $151,000. Withdrawals are taxed at a 22% future rate, netting $117,780 after tax.
With conversion, the Roth grows tax-free at the same 8% to $151,000. But you paid $16,800 in tax upfront. Invested externally at 5% after-tax for 10 years, that $16,800 grows to $27,360. Your net position: $151,000 (Roth) minus $16,800 (tax paid) plus $27,360 (external growth) = $161,560. The conversion wins by $43,780—but only if your future tax rate is 22% or higher. If your future tax rate drops to 12%, the traditional IRA net is $133,000, and the conversion net is $161,560—still a win. However, if the market grows only 3% annually instead of 8%, the traditional IRA grows to $94,000 (net $73,320 after 22% tax), and the Roth grows to $94,000. The external $16,800 at 3% grows to $22,560. Net: $94,000 + $22,560 - $16,800 = $99,760. The traditional IRA nets $73,320—conversion still wins. But if the market is flat or negative for 10 years? Traditional IRA at 0% growth stays $70,000 (net $54,600 after 22% tax). Roth at 0% stays $70,000. External $16,800 at 0% stays $16,800. Net: $70,000 + $16,800 - $16,800 = $70,000. Traditional wins by $15,400 because you kept the tax money invested instead of handing it to the IRS early.
Bottom line: Down-market conversions are only mathematically favorable if the market eventually grows at a positive rate over your holding period. If you need the money soon or cannot tolerate a flat decade, converting adds risk.
Converting a large IRA balance in a single year can spike your modified adjusted gross income (MAGI) above the thresholds for Medicare Part B and D income-related monthly adjustment amounts (IRMAA). For 2025, the first IRMAA surcharge kicks in at $106,000 for individuals and $212,000 for married couples filing jointly. A $70,000 conversion on top of $80,000 regular income pushes a single filer to $150,000—well into surcharge territory.
The surcharge adds roughly $70–$100 per month per person for Part B and another $12–$70 for Part D. Over two years (Medicare uses a two-year lookback), that’s $2,000–$4,000 in extra premiums—offsetting much of the tax savings from converting at a lower balance.
Additionally, if your MAGI exceeds $200,000 (single) or $250,000 (married), the 3.8% Net Investment Income Tax (NIIT) applies to investment income. A conversion itself is not investment income, but the increased MAGI can push other investment income into NIIT territory.
Instead of converting the entire IRA in one down year, consider a multi-year partial conversion strategy. Convert only enough each year to stay within your current tax bracket and avoid IRMAA surcharges. In a down market, convert a percentage of the loss—say 50% of the decline from peak. If the market drops 30%, convert 15% of the account each year for two years. This spreads the tax liability and reduces the risk that you convert at a temporary trough that turns out to be a false bottom.
Example: $200,000 IRA drops to $140,000. Convert $30,000 (15% of peak) in year one, $30,000 in year two, and leave the rest. If the market recovers to $200,000 by year three, you’ve only converted $60,000 of what would have been $200,000, paying tax on $60,000. The remaining traditional IRA is $140,000 minus $60,000 converted plus growth = still substantial. If the market drops further, you can pause conversions to avoid wasting tax payments.
Despite the risks, converting during a bear market is still the most common recommendation from tax planners—for good reason, in the right circumstances. The strategy works best when the following conditions line up:
If you are a high earner in a peak earning year, converting during a downturn is usually worse than waiting—you pay tax at 32% or 35% on a reduced balance, and the recovery only partially compensates. In that scenario, a better move is to contribute to a traditional IRA (if eligible) or do backdoor Roth contributions without a conversion.
Before 2018, you could recharacterize a Roth conversion—undo it—if the market dropped further after you converted. The Tax Cuts and Jobs Act eliminated recharacterizations for conversions made after 2017 (except for contributions). This means you cannot change your mind after the December 31 deadline. Once you convert, the tax liability is locked regardless of what the market does later.
The loss of this escape hatch makes the multi-year partial conversion approach even more critical. With recharacterization off the table, you must be confident in the conversion math before executing. Consider setting a “stop-loss” rule: Do not convert more than 10% of your total retirement portfolio in any single year to limit the downside if the market continues to fall.
Your practical next step is simple: pull your most recent IRA statement and note the current balance versus the highest balance in the past 12 months. Calculate the decline percentage. If it’s more than 15%, model a partial conversion equal to half that percentage of your balance, keeping the conversion amount within your current tax bracket. Execute before December 15 to allow processing time. If the numbers don’t line up, skip the conversion and wait for the next downturn—they happen every few years.
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