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— retirement

Is a Roth Conversion Right for You?

IRAs, or individual retirement arrangements, are a popular way to save for retirement, and with good reason: IRAs have numerous benefits. You may already be familiar with some of the different types of IRAs, including traditional IRAs and Roth IRAs. But you might not know it’s possible for people who typically don’t qualify for a Roth IRA to convert a traditional IRA into a Roth IRA. Depending on the details, this process is known as a “Roth conversion” or a “backdoor Roth IRA,” and in this post, we’ll walk you through two common scenarios where they’re likely to be beneficial.

IRA basics

First, let’s review a few basics about IRAs. IRAs are retirement accounts you open for yourself, unlike 401(k) plans which are offered through your employer. Roth and traditional IRAs have lower contribution limits than 401(k)s and they tend to have more flexibility around investment options. Here are some highlights at a glance:

Traditional IRAs: In general, depending on your income and whether you have a 401(k) plan at work, you get a tax deduction in the year you contribute to a traditional IRA and then pay taxes on withdrawals.
Roth IRAs: You don’t get a tax deduction when you contribute to a Roth IRA, but withdrawals after age 59 ½ are tax-free. You can’t contribute directly to a Roth IRA if you earned $161,000 and over as a single filer or $240,000 and over as a married joint filer in 2024, and those numbers rise to $165,000 and $246,000 respectively in 2025.

The tax advantages of both account types can be significant, but the tax-free growth and withdrawals you get with a Roth IRA can be especially powerful. Not everyone is eligible to contribute to a Roth IRA directly, so that’s where Roth conversions come in. A Roth conversion is when you move money from a traditional IRA to a Roth IRA. You might owe taxes in the year of the conversion, depending on whether you have any pre-tax funds in your account, but then your withdrawals from your Roth IRA after age 59 ½ are tax-free.

Let’s look at two instances where a Roth conversion is likely to be beneficial.

Scenario 1: One-off Roth conversion in a low-earning year

Let’s say you know you’re in an unusually low-earning year. Maybe you’re going to grad school or you’re taking time off to travel. You have an existing traditional IRA with some pre-tax funds in it (either because you rolled over a 401(k) from a previous employer or you contributed to one directly), and since you’re in a lower-than-usual tax bracket, now could be a good time to pay taxes on the conversion and then benefit from the tax-free growth and withdrawals you get with a Roth IRA in the future.

Let’s look at an example of how this might work. Assume your ordinary income tax rate will be 20% this year instead of the 40% it would be in a typical year. You have $10,000 (pre-tax) in a traditional IRA, and you’re wondering if you should execute a Roth conversion. If you were to leave the money in a traditional IRA for 30 years, assuming a 6% return compounded annually, it would be worth $34,460.95 after paying a 40% tax upon withdrawal. However if you converted the account to a Roth IRA, you’d pay $2,000 in taxes now (that’s your 20% current income tax rate multiplied by the value of the account), but the value of the remaining $8,000 compounded at 6% annually over the next 30 years would be worth $45,947.93 after taxes, because you wouldn’t owe any additional taxes upon withdrawal as long as you were at least 59 ½ years old. In other words, converting your traditional IRA in a low-earning year has the potential to give your retirement savings a big boost.

Scenario 2: Backdoor Roth to save more for retirement

Let’s assume you earn too much to contribute directly to a Roth IRA and you aren’t eligible to deduct contributions to a traditional IRA (either because your income is too high or because you have a 401(k) plan at work), but you still want to save some additional money for retirement. Assuming you don’t have any pre-tax money in a traditional IRA and don’t anticipate needing the funds within five years, you’re likely to benefit from a type of Roth conversion known as a “backdoor Roth.”

Again, let us explain with an example. If you fit the description above, you can either invest by opening a taxable investment account or making a non-deductible contribution to a traditional IRA. If you invest $7,000 in a taxable investment account at a 6% return compounded annually over 30 years, ignoring the taxes you’d have to pay on dividends and the gains associated with account rebalancing, your account would be worth $40,204.44 at retirement, but you’d still owe capital gains taxes when you sell to withdraw. If your capital gains tax rate in retirement were 15% then that account would only be worth $35,223.77 after taxes. However if you contributed $7,000 (after-tax) to a traditional IRA (this is the contribution limit for 2024 and 2025 if you are under 50) instead and converted to a Roth IRA, your account would be worth $40,204.44 at withdrawal because you would owe no taxes on the sales (again, assuming you were at least 59 ½ at the time).

When a Roth conversion isn’t right for you

If you’re still unsure, here are two signs that a Roth conversion probably isn’t right for you:

You plan to retire within five years. You have to wait at least five years to withdraw earnings from a Roth IRA with no penalty, even if you are 59 ½ years old (the typical age at which you can start taking withdrawals with no penalties).
You don’t have enough cash on hand to pay taxes on the conversion. These taxes could be significant if you have a lot of pre-tax money in a traditional IRA. You can estimate them by multiplying the amount of pre-tax money in your traditional IRA by whatever you expect your marginal tax rate to be.

Automation makes it easy

Typically, the Roth conversion process involves a bunch of paperwork. But at Itrust, we’ve automated the process so you can convert an Itrust SEP or traditional IRA to a Roth IRA with just a few taps on your phone. Automated Roth conversions are just one of the many tax-minimization features we offer you at no additional cost, including:

Tax-Loss Harvesting, both at the ETF level and the individual stock level
Tax-minimized withdrawals
Tax-minimized brokerage transfer
Tax-sensitive rebalancing

At Itrust, we want to help you build long-term wealth so you can meet your financial goals (like retirement!) with confidence. We hope the information in this post helps you make an informed decision about Roth conversions. For even more help planning for retirement, check out our IRA calculator.

Ask: Should I Pay Off My Mortgage Early or Invest?

Welcome to our Ask series, where we tackle your questions about personal finance and investing. Want to see your question answered here? Reach out to us on social media and we’ll try to address it in a future column.

If I have extra cash, should I use it to pay off my mortgage early or invest?

If you have cash to spare and are currently paying a mortgage on your home, you might wonder if you should use that extra cash to pay off your mortgage early (also known as prepaying your mortgage) or use it to add to your investments, like an Automated Investing Account at Itrust, instead. There’s no one-size-fits-all answer, but in this post, we’ll provide a framework for thinking about the decision.

At Itrust, we believe investing is key to building long-term wealth, but there can also be benefits to paying off your mortgage sooner. For the purposes of this post, we’ll assume you have a 30-year fixed-rate mortgage. Here are some factors to consider as you decide between paying off your mortgage early and investing.

**Make sure you really have extra cash**

Cash plays an important role in our financial lives. It’s true that having too much cash can work against your long-term financial health, but it’s important not to overcorrect: Having insufficient cash can be very stressful. Before you decide to pay off your mortgage early or invest, it pays to make sure you really have extra cash. As a rule of thumb, we think it makes sense to hold enough cash to cover the following:

A good emergency fund, with three to six months’ worth of expenses
Any significant known expenses within the next year. This could include things like an upcoming vacation, your wedding, or a large home repair. (An exception: You could also consider keeping money for large near-term expenses in an investment account with very little risk to your principal, like Itrust’s Automated Bond Ladder.)
Your regular monthly expenses that you cover out of each paycheck, like groceries and childcare

If you don’t have enough cash to cover these items without dipping into your savings, consider holding off on either putting more cash in the market or paying off your mortgage early.

Pay off your highest interest debt first

Once you’ve confirmed you do have extra cash, you should take stock of all of your debt—not just your mortgage. Some debt is far more expensive than other debt. You can tell how expensive your debt is by looking at the interest rate you’re paying on it: Debt with a higher interest rate is more expensive to you. Because of this, it usually makes sense to pay off your highest interest debt first.

Let’s imagine you have $10,000 in credit card debt and the APR (annual percentage rate) on that debt is 24.62% consistent with the national average as of June 5, 2024. Let’s also imagine you have a 30-year fixed-rate mortgage with an interest rate of 7.40%, consistent with the national average as of June 21, 2024. If you received a $10,000 bonus at work, it would make sense to pay off your credit card debt first because that debt has a significantly higher interest rate than your mortgage, and it’s probably much higher than your expected returns from investing, too.

Take a closer look at your mortgage interest rate

If you’ve already handled your high-interest debt, then it makes sense to compare the interest rate on your mortgage to your expected returns from investing. Your expected returns can be difficult to predict, but you can use tools like Itrust’s historical performance page to make a more informed guess. When you pay off debt with a known interest rate, you’re essentially getting a known rate of return on your money because you know exactly how much you’ll save in interest. Let’s say the interest rate on your mortgage is 2% (lucky you!) and your long-term expected return from investing is 5%. You could make the case for investing your extra cash, because your interest savings from paying off your loan are likely to be lower than your investment returns, even after taxes. Keep in mind, however, that “expected returns” are just that—expected, not guaranteed.

On the other hand, if your mortgage interest rate is 7% and your expected return from investing is still 5%, you might want to take the opposite approach and pre-pay your mortgage. That’s because the amount you would save in interest is higher than what you’d expect to earn on that money if you invested it.

But what about the mortgage interest tax deduction? If you itemize your tax deductions, you can deduct the interest paid on up to $750,000 of mortgage debt for homes purchased after December 16, 2017 on your tax return. This means if you prepay your mortgage, you could lose some or all of this deduction. In general, we don’t think this should be the driving force behind your decision, but it is important to be aware of the tax implications of mortgage prepayment. Here’s a very simplified example to help you think this through: If you have a mortgage interest rate of 7%, you qualify to deduct your interest, and your tax rate is 30%, then the after-tax rate on your mortgage would be 4.9% (or 7% x (1 – 30%)). Just remember that in order to get an apples-to-apples comparison, you’ll want to compare this after-tax interest rate to your expected after-tax investment return, which can be even more difficult to accurately predict than pre-tax returns.

Prepayment, recasting, or refinancing? Consider your options

Paying off debt like a mortgage early can be psychologically rewarding, but prepayment isn’t your only option. Some people incorrectly assume that prepaying their mortgage will automatically lower their monthly payments going forward, but this generally isn’t the case. However, there are alternatives to prepayment that do have the potential to lower your monthly payments. Here’s a quick overview of various options and how they compare:

Mortgage prepayment: Paying extra money towards the principal (or loan amount) of your mortgage. Prepayment allows you to pay off your mortgage faster and save money on interest, but doesn’t change the amount of your monthly payments. Occasionally, you may pay a prepayment penalty for paying your mortgage off early (more on that below).
Mortgage recasting: Paying extra money towards the principal of your mortgage, and then recalculating your monthly payments. Recasting lowers your monthly payments and saves you money on interest, but you won’t pay off your mortgage any earlier. You may also need to pay a fee of a few hundred dollars to recast.
Mortgage refinancing: Taking out a new mortgage, usually at a lower interest rate, with the goal of lowering your monthly payments and the total amount you’ll pay in interest. Refinancing can change the date you’ll pay off your mortgage in either direction, depending on the terms of the new loan. Refinancing can come with significant fees—potentially two to five percent of the new loan amount.

Consider your amortization schedule

Most of the time (assuming you have relatively standard loan terms, and not a less common arrangement like an interest-only mortgage or a balloon mortgage), your mortgage payment includes a mix of principal and interest—and over time, that mix changes. Mortgage payments are mostly interest when you first take one out, and they gradually include more principal as more time goes by and you build more equity in your home.

If your mortgage payments still include a lot of interest, there’s likely more benefit to prepaying, recasting, or refinancing. On the other hand, if you’re paying mostly principal, there’s less benefit to prepaying, recasting, or refinancing and you are more likely to be better off investing your extra cash instead.

Check your mortgage’s prepayment terms

Prepayment penalties, or fees for paying off your mortgage early, aren’t very common. But if you’re considering prepaying your mortgage, you should make sure that your lender won’t penalize you for it.

Why would lenders do this? When you prepay your loan principal, you are ultimately reducing the amount of interest you’ll pay your lender. Prepayment penalties are a way for lenders to recoup some of that lost interest, and these penalties vary in both amount and structure—you could owe a flat fee or a percentage of the loan balance, for example. Read the details of your mortgage carefully and don’t be afraid to ask your lender to clarify if you’re unsure about your prepayment terms. If your mortgage does include a prepayment penalty, make sure you are cognizant of this cost—it could tip the scales towards investing instead.

Key takeaways

To recap, here’s what we suggest keeping in mind as you consider the tradeoffs involved in prepaying your mortgage or investing.

Before you pay off your mortgage early or invest, make sure you actually have enough cash on hand.
Take stock of all of your debt and consider paying off your highest interest debt first.
Compare the interest rate on your mortgage to your expected return from investing.
Prepayment isn’t your only option. Look into recasting and refinancing if your goal is to lower your monthly payments.
You’re more likely to benefit from mortgage prepayment if you took out your mortgage relatively recently and your payments still contain a lot of interest.
Don’t forget to check your mortgage’s prepayment terms.

If you ultimately decide it makes sense to invest your savings instead of prepaying your mortgage, we suggest investing in a globally diversified portfolio of low-cost index funds like Itrust’s Classic portfolio. We’ll help you maximize your risk-adjusted returns and minimize your taxes while our software handles all of the busy work like trading and rebalancing for you.

We hope this helps!

Ask : Should I Invest My Down Payment?

I’m saving for a house. Should I invest my down payment or keep it in cash?

As you decide whether to invest your down payment or keep it in cash, you’re primarily making a decision about risk. Investing, by definition, involves some risk—but that’s why it can offer higher expected returns over the long run. Cash is very low risk, but it is likely to offer lower expected returns.

In this post, we’ll give you a framework for thinking about risk in the context of your down payment so you can decide what’s right for you. We’ll highlight the tradeoffs related to three options you might consider:

Keeping your down payment in cash
Investing your down payment in a low-risk investment like US Treasuries
Investing your down payment in a diversified portfolio

The argument for keeping your down payment in cash

Keeping your down payment in cash is a great option if you expect to buy a home imminently or if you are unwilling or unable to take any risk to your principal. If you keep your down payment in a savings account or high-yield cash account, you’ll have a high degree of certainty that your money will be there when you need it. However, you’ll be making a tradeoff when it comes to expected returns.

Over long periods of time, cash is unlikely to earn enough interest to keep up with inflation. So if you keep your down payment in cash for long enough, you could actually lose buying power. If you plan to buy a house imminently, this is unlikely to be an issue. But over longer periods of time, you could be leaving potential returns (and thus housing budget) on the table.

If you do decide to keep your down payment in cash, we suggest picking an account with a very competitive APY and adequate FDIC insurance. Many banks pay next-to nothing in interest and, as insured depository institutions, are limited to $250,000 in FDIC insurance per account holder. But the Itrust Cash Account offers an industry-leading 4.50% APY and up to $8 million in FDIC insurance ($16 million for joint accounts) through our partner banks. Plus, the Cash Account comes with no account fees and your money is readily available when you need it. By choosing a good home for your cash, you can ensure your down payment earns a competitive interest rate and is well protected in case of an unforeseen event.

The argument for investing your down payment in a low-risk investment like US Treasuries

While holding cash can feel psychologically rewarding, it could make more sense to invest your down payment in a low-risk investment like US Treasuries. While they have a lower expected long-term return than a diversified portfolio of US equities, US Treasuries can offer a steady yield until maturity and the interest you earn is exempt from state and local income taxes. At the same time, US Treasuries are backed by the full faith and credit of the US government, which is why they are considered among the safest investments in the world. If held to maturity, US Treasuries pose virtually no risk to your principal, although you run the risk of losing some principal if you sell before then (if interest rates go up, the price of the bond may decrease).

Because of these benefits, US Treasuries can be a very attractive and low-risk way to invest your down payment whether you’re buying a home in a few months or a few years. You could argue that US Treasuries are the sweet spot between holding your down payment in cash and investing it in a diversified portfolio. And if you want to minimize the risk associated with interest rate fluctuations, you could consider building a US Treasury ladder (a type of bond ladder) with US Treasuries of varying maturities.

At Itrust, we built our Automated Bond Ladder (a ladder of US Treasuries) to make it easy to benefit from a bond ladder strategy without any of the hassle it normally entails for a low annual advisory fee of 0.25%. The Automated Bond Ladder can be a great way to invest your down payment if you want to keep your level of risk very low and take advantage of state income tax exemptions, and it comes with up to $500,000 of SIPC insurance. When you’re ready to buy a home, your ladder is very liquid and there are no early withdrawal penalties. You can even set a target withdrawal date for your Automated Bond Ladder, which can be useful if you have a timeline you’re fairly confident in.

The argument for investing your down payment in a diversified portfolio

Finally, if your time horizon for buying a home is five or more years away, you might consider keeping your down payment in a diversified portfolio of low-cost index funds. It’s true that this type of portfolio (like Itrust’s Classic portfolio) comes with more risk than cash or US Treasuries, but that risk could also get you higher expected returns over the long run. There’s also a well established relationship between risk and time horizon, and the longer you stay invested, the lower your probability of loss.

As you get closer to actually buying a home, it could be wise to shift your down payment from a diversified portfolio to one of the lower-risk options discussed above. The reason for this? Financial markets are unpredictable in the short term and can be volatile. It would be unfortunate if the market declined steeply at the exact time you needed to liquidate your investments to purchase a home—you could end up with a smaller down payment than you’d hoped for, and you’d also be selling investments when they’re down (which is nice to avoid if you can).

Key takeaways: Should you invest your down payment?

There’s no one-size-fits-all answer to whether or not you should invest your down payment, but there are some rules of thumb to keep in mind:

If you plan to buy a house imminently, it probably makes sense to keep your down payment in cash.
If you plan to buy a house soon (a few months to a few years from now) and want to earn a higher yield with very little risk, consider investing in US Treasuries.
If you’re at least five years away from buying a home and are willing to take on additional risk in order to potentially grow your down payment, a diversified portfolio of index funds could be a good fit.

It’s also an option to split your down payment if you believe you can benefit from a variety of approaches—you don’t have to keep all of it in one place. For instance, you could keep half of your down payment in cash and the other half in a diversified portfolio of low-cost index funds if you wanted to balance out a higher-risk option with the lowest risk option.

We hope this helps!

What an Election Year Means for Your Investments

Election years bring uncertainty, and this year’s presidential election is no exception. However, you might be surprised to learn that history shows they usually don’t have much impact on your portfolio. In this post, we’ll dig into the data.

What history tells us about investing during election years

To understand the impact of presidential election years on investments, we looked at US stock market data all the way back to 1927, using Kenneth French’s data library. First, we analyzed mean annual returns for the US stock market for all years 1927-2023 compared to election years during that period of time.

We found that the mean annual total return for non-election years was 12.1% and the mean annual total return for election years was 11.7%. The chart below shows these returns. However, we also performed a t-test (a way of discerning whether or not results are statistically significant) and found that the difference between election year and non-election year returns was not statistically significant. In other words, US stock market total returns are pretty much the same on average whether or not it’s an election year.

Next, we compared average annual volatility in the US stock market in all years from 1927-2023 to see if election years are meaningfully more volatile than non-election years. We found that mean volatility in non-election years was 15% over that time period, and mean volatility in election years was 15.3%. However, once again, our t-test confirmed these differences were not statistically significant, meaning the US stock market, historically, is just about as volatile on average in an election year as it is in a non-election year.

Finally, we compared the average maximum drawdown (or largest decline from a recent peak) in the US stock market in all years from 1927-2023. We found that the average maximum drawdown was slightly greater in non-election years at -16.0% than in election years at -14.6%. Again, however, these differences were not statistically significant.

It’s worth noting that our analysis picked up some small differences between election years where Republican candidates won and Democratic candidates won. The US stock market had slightly higher mean returns, lower mean volatility, and smaller maximum drawdowns during years when a Republican won the presidential election. Here again, our hypothesis testing did not find evidence that any of these differences were statistically significant. Especially given the small number of total data points, the historical differences observed are small enough to be attributed to random chance.

Even if the market does decline or become more volatile in the short term (which is always possible), it’s important to keep an eye on the long term. Risk of loss generally goes down as your investing time horizon gets longer. If you plan to be in the market for the long run, fluctuations in your account balance today could end up being blips on the radar in the future.

Should you adjust your investment strategy in an election year?

Put simply, we don’t think so. As tempting as it may be, timing the market usually doesn’t work. Any information you have that you think might impact investment performance is presumably already broadly available. This means it’s already priced in, and you’re unlikely to come out ahead.

Instead, we suggest focusing on what you can control:

Managing your risk: Invest in a portfolio that is appropriate for your risk tolerance, and rebalance it over time to ensure you don’t drift too far from your target allocation. Itrust automates this process so you don’t have to think about it.

Keeping your costs low: Choose low-cost index funds whenever possible, and invest with a service that charges a low management fee (Itrust’s annual fee is just 0.15%).

Minimizing your taxes: Harvest losses and use them to help lower your tax bill. The process of tax-loss harvesting can be time consuming if done manually, but Itrust does this automatically and at no extra cost.

Major events like elections can rattle investors. And while it’s true that there are some small differences in the annual returns, volatility, and maximum drawdowns observed in years when the United States elected a new president, it’s worth remembering that the number of data points is very small and the differences were not statistically significant. If you look at the big picture, these small differences in performance are ultimately not worth paying much attention to.