Don't Miss the Deadline to Undo a Roth Conversion
Sometimes it makes sense to cancel a conversion and get the chance for a do-over.
I converted a traditional IRA to a Roth last year and paid taxes on the money. Since then, however, the investments have lost value. Do I still have time to undo the conversion, get a credit for the taxes I paid and then reconvert the IRA to a Roth to lower my tax bill?
Yes, you have until October 17 to undo a 2015 conversion. You can undo all or part of your Roth conversion (called a recharacterization), get back the money you paid in taxes, and then convert the money again later. If you plan to reconvert the money, you must wait at least 30 days after the recharacterization and until the year after the original conversion -- so you just need to wait 30 days to reconvert your 2015 conversion.
Converting a traditional IRA to a Roth can be a great way to provide tax-free income for retirement. You pay taxes on the money you convert (except for any portion attributable to after-tax contributions), and the Roth grows tax-free after that. But there are several reasons why you might want to undo a Roth conversion:
Your investments lost value since you converted the traditional IRA to a Roth. You paid income taxes based on the IRA’s value at the time of the conversion. But if the value of the investments has declined since then, you can undo the conversion and then convert the account back to a Roth at the lower value, and pay taxes on the smaller amount.
You're in a lower tax bracket now. If you stopped working or lost your job and will be in a lower tax bracket in 2016 than you were in 2015, you could undo the conversion and reconvert and pay taxes at the lower rate.
The conversion made you subject to the Medicare high-income surcharge. If your adjusted gross income plus tax-exempt interest income is higher than $85,000 if single or $170,000 if married filing jointly, you may have to pay a high-income surcharge on top of your Medicare Part B and Part D premiums. In 2016, that surcharge adds an extra $48.70 to $268 (depending on your income) to your Part B premiums each month, and an extra $12.70 to $72.90 to your Part D premiums each month. (See Medicare Premiums: Rules for Higher-Income Beneficiaries for more information.) But you can undo at least some of the conversion to fall below the income cut-off for the surcharge. You can then spread your conversions over several years to help stay below the threshold each year.
The conversion made more of your Social Security benefits subject to taxes. Whether your Social Security benefits are taxed depends on your provisional income. Your provisional income is your adjusted gross income (not counting Social Security benefits), plus nontaxable interest and half of your Social Security benefits. If it’s between $25,000 and $34,000 and you file taxes as single or head of household, or between $32,000 and $44,000 and you file a joint return, then up to 50% of your benefits may be taxable. If your provisional income is more than $34,000 if single or more than $44,000 if married filing jointly, up to 85% of your Social Security benefits may be taxable. If you undo a portion of your Roth conversion and spread your conversions over several years, you may be able to stay below the income thresholds.
For more information about factors to consider when deciding whether to recharacterize a Roth conversion, see Deadline Nears for Reversing Your 2015 Roth IRA Conversion.