Help! I Wish I Could Undo My Roth Conversion!!
Back in the fall of 2010, I wrote a two-part article on factors to consider in whether or not to convert your IRA to a Roth IRA.
Although a conversion is taxable, an limited opportunity existed to spread that tax over a two-year period (2011 and 2012) if the conversion took place in 2010, and many took advantage of that.
The amount of tax is based on the value of the IRA at time of conversion.
Now, however, with recent steep declines in the market, many are faced with paying taxes on an amount that is substantially higher than their account is currently worth.
In other words, paying tax on money they no longer have!
For example, one man I know converted his IRA to a Roth when the account was worth roughly $17,500. He tells me that as of this writing, that account has gone down in value to about $15,000, and he's not happy about paying taxes on $2,500 he no longer has.
Good news if this is you... if you act soon and so desire you can still "undo" your previous conversion and avoid that tax!
Undoing a conversion to a Roth IRA is known as a recharacterization. A recharacterization has to be completed by the last date, including extensions, to file your taxes for the year of conversion. For most folks, that means October 15th.
Thus, if you converted to a Roth in 2010 and wish to "recharacterize", you must do so by October 15, 2011. If you wish, you can recharacterize all or only a portion of what you converted originally.
And what if you've already filed your 2010 return and elected for whatever reason to pay the tax on that return rather than spreading it over 2 years? There's good news for you to!
You can still recharacterize the conversion by October 15, and then file an amended tax return for a refund of the taxes previously paid on the conversion.
Also, and this is a handy planning maneuver, what you recharacterize to a traditional IRA can be reconverted back to a Roth in the next tax year after the conversion, or 30 days after the recharacterization, whichever is later.
Why would you want to do that? Well, at a lower account value, you would still have your Roth IRA, but pay tax only on the lower value.
Bear in mind, at that point the tax will be due for the year of conversion (the two-year tax spread is not available), so some analysis is wise to see if this makes sense as a planning move.
There are other good reasons why you might want to undo a conversion other than a decline in the value of the account. Some other reasons to recharacterize include:
-You now expect your taxable income for the year(s) of tax payment to be higher than originally anticipated, and the IRA conversion will bump you into a higher income tax bracket.
-You now foresee that your taxable income in retirement will be lower than you anticipated, reducing the benefits of a Roth IRA's tax-free distributions.
-You now don't have enough cash to pay the taxes that will be due.
Recharacterizing your IRA conversion may be a smart move that can reduce your tax liability, but the rules can be confusing so make sure you check with a professional adviser to understand what the impact will be on you.
No one has a crystal ball, but you can never have too much information when making a move like this.
