It’s not too late for taxpayers to “undo” a Roth IRA conversion. The deadline to recharacterize — or reverse — the conversion is October 15. It’s an opportune time for advisors to review Roth assets with investors.
In general, individuals have until October 15 of the following year to recharacterize a Roth IRA conversion and transfer the assets back into a traditional IRA, according to the Internal Revenue Service. Those who converted a traditional IRA to a Roth IRA in 2013 have until October 15, 2014.
The recharacterization can be done regardless of whether a taxpayer has requested an extension to file their tax return. In fact, if they choose to recharacterize a Roth conversion that was already reported on their tax return, they may file an Amended U.S. Individual Income Tax Return.
Why reverse a conversion?
1. Avoid taking a tax hit. When a traditional IRA is converted to a Roth IRA, taxable income is generated. If the additional income will have a negative effect on the individual’s personal tax situation, they may choose to recharacterize. They can also choose to recharacterize only a portion of the account and leave the remaining assets in the Roth IRA.
2. The Roth could lose value. Market losses can cause the value of the converted Roth IRA to depreciate. Consider this example: If a taxpayer converted a traditional IRA valued at $100,000 during 2013 that is now worth only $80,000, they would still be required to report the taxable income of $100,000. A recharacterization can help avoid taxes on the loss.
Is the recharacterization final?
You may recharacterize a Roth conversion and decide to reconvert in the future. However, there are time limits. 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.
Roth conversion as a planning topic
Discussing Roth IRA assets can lead to a deeper review of retirement and tax-related planning needs. Individuals should work closely with a tax professional regarding their personal financial situation. For more information on recharacterization, download this investor education piece, “Converting a Traditional IRA to a Roth IRA,” from putnam.com.