Recharacterizing a Roth Conversion

When a traditional IRA is converted into a Roth account, the transaction is treated as a taxable distribution from the traditional IRA, followed by a contribution of the distributed amount to a Roth IRA. Such a conversion triggers an income-tax bill based on the traditional IRA’s value on the conversion date.

If a conversion took place in early 2008, the resulting Roth IRA is now most likely worth considerably less than than it was on the conversion date. However, the tax bill is based on the value of the assets when the conversion took place, which means a tax liability will exist on money that has since been lost.

Thankfully, that ill-advised Roth conversion can be reversed. In fact, recharacterizing the conversion makes it like the conversion never happened, and as a result, that inflated conversion tax bill will also disappear. Conversions can be recharacterized until October 15th of the year following the transaction.

However, converting a traditional IRA to a Roth IRA can still be an appropriate strategy if the timing is right. After recharacterizing, there is a timing restriction as to when the account can be reconverted to a Roth IRA. An investor must wait 30 days after recharacterizing before reconverting.

As always, you should speak with a fee only, independent financial planning professional to make sure this investment strategy is appropriate for your individual circumstances.