A very important deadline is quickly approaching if you made a Roth IRA conversion in 2008 and suffered a decline in your investment. You have until October 15th to recharacterize or undo your conversion and recover the taxes that you paid on the conversion.
To keep it simple, let’s say, for example, that you converted $100,000 from your traditional IRA in June of 2008. It’s quite possible that with the steep decline in the market over the past year that your Roth IRA is now valued at $50,000. Since you had to pay taxes on your Roth IRA conversion up front (or the taxes are due by October 15th), you are probably not a happy camper right now.
The good news is that you can do something about it. By recharacterizing, you can reverse the conversion and turn your Roth IRA back into a traditional IRA. It’s as though the conversion never happened. True, the value of your IRA is still only $50,000, but that’s where it would have been anyway with the market collapse and at least you can recover the taxes that you paid to make the conversion.
The recharacterization can be accomplished by filing the appropriate paperwork with the IRA custodian. Then, file an amended tax return using form 1040-X to obtain a refund of the overpaid taxes. If you haven’t yet filed your taxes, there is no need to file an amended return — simply file your return by the October 15th deadline.
One more point to consider - after the recharacterization, you could then do another Roth IRA conversion of the reduced amount. This strategy leaves you with a Roth IRA of the same value before the recharacterization, but with far less taxes due to the IRS.
As you might expect, there are waiting rules for these “reconversions”. You must wait until the calendar year after the original conversion or 30 days after the original conversion - whichever is longer - to make a conversion with the same money. However, if you made only a partial conversion, the waiting rule does not apply.
Throughout 2009, our office has been proactive in advising our clients about recharacterizations and reconversions. We strongly advise that if you made a Roth IRA conversion in 2008 and haven’t yet spoken with your financial or tax professional, do so immediately. Remember, the deadline for recharacterizing 2008 Roth IRA conversions is just weeks away. After October 15th, it will be too late. If you have the 2nd edition of Retire Secure!, turn to page 135 for a further look at recharacterizations. You can also call our office toll-free at 1-800-387-1129.