From Dip to Dynasty: Roth Conversions for Generational Wealth

Periods of market downturn often trigger anxiety and inaction among investors. Such periods can offer uniquely favorable conditions for executing Roth conversions – strategic transfers of assets from tax-deferred to tax-exempt accounts. When you plan carefully, converting during a down market can create positive results by reducing your taxes, capturing tax-free growth, and building stronger foundations for generational wealth.

Combining tax strategy with behavioral finance insights, the following illustrates how you and your family can capitalize on market declines to improve long-term wealth outcomes and overcome the psychological barriers that often prevent action.

How Market Dynamics Favor Roth Conversions

A Roth conversion entails transferring funds from a traditional, pre-tax retirement account – such as an IRA or traditional 401(k) – into a Roth account, where future growth and withdrawals are tax-free if certain conditions are met. The act of conversion triggers income tax on the converted amount, but it eliminates future tax exposure on those funds. In contrast, traditional IRAs defer taxes until withdrawal, creating future taxable income for both the owner and heirs.

Economic research shows that Roth accounts help hedge against uncertain future tax rates. Professor Marie-Eve Lachance found that Roth conversions often improve long-term welfare when tax rates are likely to rise (Journal of Pension Economics & Finance, Cambridge University, 2012). Down markets enhance this benefit because account balances are temporarily lower, reducing the taxable amount recognized at conversion.

Suppose an investor has a $1 million IRA that has dropped to $800,000 in a down market. Deciding to convert assets to a Roth means paying tax on a smaller figure. When the market rebounds, all future gains occur inside the Roth, free of tax. This allows investors to “pay tax on the dip” and enjoy tax-free recovery later.

However, executing this effectively requires liquidity to pay conversion taxes from non-retirement assets, a sufficiently long-term horizon, and confidence that either future personal or estate tax exposure will be higher than today’s. Without those elements, conversions can accelerate taxes without long-term offsetting benefits. Generally, investors have had confidence that tax rates are increasing, but there have been historical reductions in the past.

The Generational Wealth Opportunity

From a family wealth perspective, a Roth conversion is more than a tax move – it’s a legacy strategy. Converting now effectively pre-pays income taxes, reducing the size of the taxable estate while shifting growth into an account that bypasses future taxation. Subsequently, market appreciation compounds tax-free outside the estate, an effect magnified when the post-conversion time horizon is long, thereby benefiting heirs more upon inheriting the account. Additionally, heirs have up to 10 years to withdraw funds after inheritance, further emphasizing the ability to achieve tax-free growth.

The conversion acts as a tax arbitrage across generations – pay less tax today to save heirs from paying more tomorrow. Furthermore, maintaining a mix of traditional and Roth assets helps manage uncertainty around future taxes.

Behaviorally, this planning lens requires reframing the Roth conversion not as a current-year cost, but as a legacy investment. Research on time preferences reveals that people undervalue long-term rewards and focus too much on short-term costs (Frederick, Loewenstein & O’Donoghue, 2002). Paying conversion taxes feels painful now, even though it can yield much greater long-term benefits for heirs. Framing the conversion as an “investment in legacy” rather than a “tax hit” helps families make better decisions and stay aligned with long-term goals. Market downturns, though emotionally challenging, become fertile moments for tax-efficient legacy creation when investors can commit to the strategy.

Behavioral Barriers and How to Overcome Them

While the economic logic of down-market conversions is compelling, behavioral finance reveals why many investors fail to act. Loss aversion, mental accounting and temporal discounting each contribute to missed opportunities.

Loss aversion, initially documented by Kahneman and Tversky, causes individuals to experience losses about twice as intensely as equivalent gains (Kahneman, D., & Tversky, A., 1979). In a declining market, investors interpret reduced account balances as realized losses, making them reluctant to “lock in” those losses through any transaction – even one with future upside. In behavioral terms, conversion is incorrectly perceived as confirming a loss, rather than exploiting it.

Mental accounting further distorts decision-making. Investors compartmentalize “taxes” and “investments,” perceiving the conversion tax as a separate unpleasant expense rather than a component of total after-tax return. Advisors can improve outcomes by modeling side-by-side scenarios showing how post-tax wealth grows faster under conversion, especially when market recovery is expected (Chetty et al., American Economic Review, 2009).

Finally, time discounting weakens long-term planning. Investors over-weight immediate costs and under-value distant gains (Laibson, 1997). Temporal reframing can be translated into present-value language: “Each dollar of tax paid today can save your heirs several tax-free dollars tomorrow”. Understanding this strategy may correct undervaluation of delayed rewards.

Spotting behavioral reactions often takes an objective professional who can provide guidance on cutting through internal biases and help translate into rational decision making. Advisors can help individuals recognize and address behavioral dynamics so families can systematize conversion decisions and treat them as part of a broader, rule-based wealth-transfer policy rather than an emotional market-timing gamble.

Conclusion

A Roth conversion during a down market is both a financial and behavioral opportunity. Lower valuations reduce taxable income, future recovery becomes tax-free, and heirs benefit from more efficient wealth transfer. The challenge is psychological: overcoming fear, reframing the tax cost burden, and acting with a long-term mindset.

When behavioral science meets sound tax strategy, downturns transform from periods of hesitation into moments of generational advantage. The families who plan and act – rather than react – will likely find that volatility, managed wisely, can be one of the most powerful engines of enduring wealth.

References

• Chetty, R., Looney, A., & Kroft, K. (2009). Salience and taxation: Theory and evidence. American Economic Review.
• Frederick, S., Loewenstein, G., & O’Donoghue, T. (2002). Time discounting and time preference. Journal of Economic Literature.
• Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica.
• Lachance, M. (2012). Roth versus traditional accounts in a life-cycle model with tax risk. Journal of Pension Economics & Finance.
• Laibson, D. (1997). Golden eggs and hyperbolic discounting. Quarterly Journal of Economics.

Disclosures:

Apella Capital, LLC (“Apella”), DBA Apella Wealth, is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered or excluded or exempt from registration requirements. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Apella Wealth provides this communication as a matter of general information. Any data or statistics quoted are from sources believed to be reliable but cannot be guaranteed or warranted.