I converted my traditional IRA to a Roth in 2015, but my investments have lost a lot of money since then. How do I undo the conversion? Is there a benefit to making the change before I file my taxes this year?
You have until October 17, 2016, to undo a Roth conversion that was made in 2015 (a procedure called "recharacterization"), but the sooner you make the move, the faster you'll be able to reconvert the money. You'll get back the money you paid in taxes on the conversion (or avoid having to pay the tax bill if you undo the conversion before you file your taxes). You can then reconvert the money, and your tax bill on the reconversion (on your 2016 tax return) will be based on the lower account value, if you act before your investments rebound.
You have to wait until the year after the original conversion, or 30 days after the recharacterization, whichever is later, to reconvert the money. In your case, because you're recharacterizing a conversion you made last year, you need to wait at least 30 days after the recharacterization to reconvert any or all of the money to a Roth.
If you recharacterize after you file your 2015 tax return, you will need to file an amended return to get back the money you paid in taxes on the conversion. But if you undo the conversion before you file your 2015 return, you'll still have to report the conversion and recharacterization on your tax return, but you won't owe taxes on the conversion.
Report the amount converted on line 15a of the Form 1040 ("IRA distributions") and report $0 on line 15b ("taxable amount" -- unless other distributions were taken throughout the year), says Jeffrey Levine, chief retirement strategist for IRA consulting firm Ed Slott and Co. He recommends attaching a statement to your 1040 form explaining the recharacterization. "Include the amount converted, the amount recharacterized and the dates of the transaction," he says.
Contact your IRA administrator to find out what steps you need to take to recharacterize the conversion. You may not be able to make the change online. Vanguard, for example, has a recharacterization kit that includes the forms you must submit and goes into detail about the options and procedures.
Before deciding to convert, consider the impact on your taxes. If the value of the investments went down but your income tax bracket went up, you may not come out ahead by recharacterizing a 2015 conversion and reconverting in 2016. Also consider the impact a conversion may have on other areas of your finances, such as your Medicare Part B and Part D premiums if your adjusted gross income (plus tax-exempt interest income) tops $85,000 if you're single or $170,000 if married filing jointly. Reconverting in 2016 may also boost your income above the limits to qualify for certain tax breaks, such as the American Opportunity Credit, or to make new Roth contributions.
As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.