Now is a great time to review Roth IRA conversions that occurred during 2011 within your book of business, and, if appropriate, contact clients to confirm they would like to keep the conversion in place. Roth IRA owners who converted accounts in that period have until October 15, 2012 (the tax filing deadline plus extension), to decide if they want to recharacterize, or “undo,” a conversion.
Typically, there are two reasons to consider recharacterizing a Roth IRA conversion:
(1) The additional, taxable income from a conversion will have serious negative implications on the investor’s personal tax situation. It is important to note that the investor may also choose to recharacterize a portion of the conversion and allow some of the funds to remain in the Roth IRA.
(2) Since the conversion, the value of the Roth IRA has depreciated significantly. For example, assume an investor converted a traditional IRA valued at $100,000 during 2011 that is now worth only $80,000. From a tax perspective, the investor may want to recharacterize the conversion to avoid reporting $100,000 of ordinary income on an account that is now worth only $80,000. By recharacterizing, the investor could transfer the Roth IRA funds back into the traditional IRA without any taxes or penalties.
It’s important to remember that there are restrictions on converting traditional IRA assets to a Roth IRA after a recharacterization has occurred. If a recharacterization occurs in the same calendar year as the original Roth conversion, an IRA account owner has to wait until either the next calendar year or 30 calendar days — whichever is longer — before converting again. In cases where the original Roth conversion occurred in the previous calendar year, the IRA owner would have to wait until 30 days after a recharacterization before converting those assets again.
Regardless of whether your clients consider a recharacterization, this could be an opportunity to engage them on their retirement and tax-related needs. As always, it’s critical for clients to work closely with their tax professional regarding their personal circumstances.
For more information on recharacterization, download our Converting a Traditional IRA to a Roth IRA investor education piece.