With an October 15 deadline to “undo” a Roth IRA conversion, now is an opportune time to reach out to clients who may want to reverse that transaction.

Clients who converted a traditional IRA to a Roth IRA in 2012 have until October 15, 2013, to reverse or “recharacterize” the conversion, transferring the assets back into a traditional IRA.

There are two main reasons to consider recharacterization.

1. A Roth IRA conversion creates taxable income. If the additional income will have a negative effect on the client’s personal tax situation, they may choose to recharacterize. They may also choose to recharacterize only a portion of the account and leave the remaining assets in the Roth IRA.

2. The value of the Roth IRA may depreciate as a result of market losses. Consider this example: If a client converted a Traditional IRA valued at $100,000 during 2012 that is now worth only $80,000, the client would still be required to report the taxable income of $100,000. In order to avoid taxes, the client could recharacterize and transfer the funds back into the Traditional IRA.

Reconverting has time constraints
After recharacterization, a client may decide in the future to reconvert the account to a Roth IRA. But there are time constraints on this action. If you convert assets from a Traditional IRA to a Roth IRA and then transfer that amount back to a Traditional IRA during the same year, you must wait until the following tax year to reconvert the account to a Roth IRA. In addition, you may not reconvert those assets to a Roth IRA for 30 days following the recharacterization.

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Source: IRS, 2013.

Even if a client decides not to reverse the action, discussing Roth IRA assets can lead to a deeper review of retirement and tax-related planning needs. It is also important to remind clients that they should work closely with a tax professional regarding their individual financial situation.
For more information on recharacterization, share this investor education piece: “Converting a Traditional IRA to a Roth IRA,” or visit the IRS publication on “Individual Retirement Arrangements.”

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