Recharacterization of 2010 Roth IRA Conversions

Published on Tuesday, August 16, 2011

With the recent volatility in the stock market we wanted to alert our clients who converted IRA’s to Roth IRA’s in 2010 to a potential planning issue that may warrant some attention in the next 60 days.

The law allows a taxpayer to reverse, or cancel a 2010 Roth conversion by filing an amended tax return prior to October 17, 2011. Depending on what has happened to your investments since converting to a Roth IRA and also depending on your particular circumstances and outlook on the future tax and investment picture, it could benefit you to reverse your Roth conversion and transfer the funds back to a traditional IRA. For instance, if the value of your IRA has decreased substantially since the conversion to a Roth, it might make sense to cancel the conversion and do the Roth conversion again at a lower value in 2011 or 2012. A Roth conversion at a lower value results in a lower tax. The re-conversion at a lower value can take place after waiting 30 days from the date the cancellation of the original Roth conversation occurs.

The downside to making this “re-characterization” is waiting 30 days to convert again. During this waiting period, the value of the IRA could increase significantly and eliminate any advantage gained in taking this action. Additionally, the original conversion may have been structured with a 2 year deferral of tax which would not be available if this strategy were implemented. However, the value of the 2 year deferral is questionable because interest rates are close to zero which minimizes the time value of money, mathematically diminishing the value of this tax deferral.