January 06, 2009


I'm sure all of you have had moments (financial or otherwise) where you've wished you could have a "do-over"... Typically, you won't experience that sensation when you've done the right thing. This year could be an exception for you if you've converted/rolled over an IRA to a Roth IRA account...

For example: In 2008 suppose you converted a Traditional IRA (or other tax deferred retirement account) to a Roth IRA (typically considered a pretty savvy move); this enables you to pay taxes now and withdraw the funds later TAX FREE! Obviously, since the funds have yet to be taxed, this conversion will result in a taxable "event." You will be sent a tax 'bill' for the full amount being transferred; so even though the account is in all likelihood worth significantly less than what was transferred earlier in the year, the taxed amount will be on the sum being transfered. For someone in a 25% tax bracket, rolling $20,000, the taxes would equal $5,000. If they had instead waited until the end of the year when the account was only worth $12,000, the tax bill would instead have only been $3,000 ($2,000 or 40% less!). Fortunately, the IRS allows for a 'do-over' of the conversion so that you can in effect pay the smaller tax bill! The process, recharacterization, enables you to "put your money back" into a traditional IRA so that you won't need to report the original conversion to the IRS. You can then convert to a Roth IRA later on and pay taxes on the resulting smaller balance.

Be aware that an IRA that has been switched to a Roth earlier in the year and then switched back (to a Traditional IRA) can’t be reconverted to a Roth again this year. The 'reconversion' has to be delayed until at least January 1 or if later, 30 days after the IRA was switched back to the traditional.

* You have until October 15, 2009 to undo a 2008 Roth conversion. See IRS Publication 590, Individual Retirement Accounts (IRAs), for more information.

** As an aside ... If you have money in a Traditional IRA and want to convert it to a Roth IRA, you are unable to do so if your Adjusted Gross Income is greater than $100,000/year. This is especially frustrating if your income is greater than the Roth IRA Phaseout/Contribution Limits that leaves you unable to take advantage of one of the [The?] greatest retirement planning tools. 2010 will mark the removal of this Roth IRA Conversion Limit. In 2010, these income limits will become extinct, so that anyone, regardless of income, can convert from Traditional IRAs to Roth IRAs (you'll also be able to split the tax bill over two years).

You don't want to screw up your do-over ... it is wise to consult with a professional: the IRA custodian (where you have your account), a financial planner, a tax planner, or all of the above.