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October 07, 2011 |
Deadline Nears For Roth IRA 'Do-Over' |
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In the world of finance and investing, people rarely get opportunities
for do-overs. One exception, however, is the rules governing Roth
conversions. But people who want to take advantage of this do-over for
their 2010 conversion need to act fast.
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By Robert D. Lepson
In the world of finance and investing, people rarely get opportunities for do-overs. One exception, however, is the rules governing Roth conversions. But people who want to take advantage of this do-over for their 2010 conversion need to act fast.
That’s because people who convert funds from their traditional individual retirement account to a Roth IRA have until the very last tax filing deadline—including extensions—to undo or “re-characterize” that conversion. For those who converted last year, that deadline is Oct. 17.
This year’s deadline is particularly important because so many people took advantage of changes in the rules governing Roths that took effect in 2010. These changes eliminated income limits on Roth conversions, allowing lots of people previously unable to convert to shift their retirement funds to a Roth.
Among those who might want to re-characterize are those who feel they can no longer afford the big tax bill triggered by conversion. Others are investors who are looking for savings after seeing their Roths plummet in value since they converted.
Investors must pay income tax on all of the pre-tax assets moved from their traditional IRA to a Roth. Given recent market volatility, many of those tax bills are based on a higher asset value than currently exists. That means there could be significant tax savings from simply undoing the conversion, waiting 30 days and then converting to a Roth again.
How much savings? That depends on both the size of the loss and the investors tax bracket. Someone in the 35% bracket with a $100,000 loss would save $35,000 in taxes just by re-characterizing.
Roths have several advantages over traditional IRAs. While the accounts are funded with after-tax money, most future withdrawals—including contributions and earnings—are income tax free. Moreover, there are no minimum distribution requirements, such as those that kick in at age 70½ for holders of traditional IRAs.
To re-characterize, investors who have already filed their taxes must file an amended return. Those who have yet to pay their taxes, however, can re-characterize as part of their regular filing. The process of putting the money back into the traditional IRA—which should be done through an IRA to IRA direct transfer—must also be completed by the deadline. If the money is put back in any other manner, the transfer will create a taxable distribution, making the re-characterization null and void.
Those who choose to re-characterize lose the one-time option of spreading the tax liability over their 2011 and 2012 returns, rather than reporting the whole amount on their 2010 taxes. But taxpayers can achieve much the same thing by simply re-converting half of those assets to a Roth before year-end and converting the second half in early January 2012.
Robert D. Lepson, a vice president of Braver Wealth Management in Needham, Mass., is a Certified Financial Planner, Chartered Financial Consultant and Chartered Life Underwriter. He can be reached at rlepson@thebravergroup.com.
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Deadline Nears For Roth IRA 'Do-Over' |
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