Don't Miss the Roth Recharacterization Deadline
I've lost a lot of money in my IRA over the past few months and am wishing that I hadn't converted it to a Roth last year. I had to pay taxes on so much more money than I have in the account now. Is there anything I can do?
Yes. There is a special strategy that could save you thousands of dollars in taxes if you converted a traditional IRA to a Roth in 2007. But you need to act quickly before the deadline for making the change.
You have until October 15, 2008 -- this Wednesday -- to undo the conversion and get back the money you paid in taxes. To do so, you'll need to ask your IRA administrator to do a "recharacterization," which is the technical term for undoing a Roth conversion. The IRA administrator will switch the account back to a traditional IRA, and you'll be able to file an amended return to get a refund of the taxes you paid on the conversion. You'll have to wait at least 30 days to convert the IRA back to the Roth. Because your account is worth so much less, the tax bill will be much smaller this time. This move could save you thousands of dollars in taxes.
For example, say you converted a $100,000 traditional IRA to a Roth in 2007 but the account is now worth $75,000. If you hadn't made any non-deductible contributions to the IRA through the years, then you had to pay taxes on the full $100,000 conversion -- which would have resulted in a $25,000 tax bill if you're in the 25% income-tax bracket.
But if you recharacterize then convert the $75,000 account back to a Roth in 30 days, then you'd owe just $18,750 in taxes -- resulting in a tax savings of $6,250.
You don't need to file the amended return right away, but you might as well because you'll be getting money back. Your refund check should arrive within about six to eight weeks, says Michael Martin, an enrolled agent in Independence, Mo., who represents taxpayers before the IRS. Martin recommends re-filing your entire return because undoing the conversion could have a ripple effect in other parts of your taxes. The converted amount will no longer be included in your adjusted gross income, so you may end up qualifying for other tax breaks that result in an even larger refund. See Form 1040X for the amended return, and the IRS's Instructions for Filing an Amended Return.
You have a longer deadline for recharacterizing an IRA you converted in 2008. In that case, you have until October 15, 2009, to make the change. Then you have to wait until the year after the original conversion was made to reconvert the account to a Roth, or at least 30 days after recharacterizing, whichever is later. So if you recharacterize a conversion you made in 2008, you'll have to wait until 2009 to roll the money back over into a Roth.
As always, you can convert a traditional IRA to a Roth only in years when your adjusted gross income is below $100,000, whether single or filing jointly (that $100,000 limit doesn't include the amount of money you're converting). But that income limit will disappear in 2010.
For more information, see the recharacterization and reconversion section of IRS Publication 590, Individual Retirement Arrangements.
Got a question? Ask Kim at firstname.lastname@example.org.