In some instances it makes tax and financial sense to
convert a traditional IRA to a Roth IRA.
A traditional IRA generally permits tax deductible contributions (but
not for certain higher income taxpayers who actively participate in an employer
retirement plan), and distributions are taxable income. A Roth IRA does not permit deductions for
contributions, but future qualifying distributions are excluded from taxable
income. In 2015, the ability to
contribute to a Roth IRA is restricted once adjusted gross income exceeds $183,000
for joint filers and $116,000 for single filers. However, there is no income restriction on
the ability to “convert” a traditional IRA to a Roth IRA. A conversion is best handled by means of a
direct trustee-to-trustee transfer of funds from the traditional IRA to a Roth
IRA.
The amount converted to a Roth IRA is treated as a taxable
distribution. If you converted to a Roth
IRA in 2014, and the value of the Roth IRA account has dropped such that the
taxable amount of the conversion exceeds the current value of the account, you
should consider “recharacterizing” the Roth conversion by October 15, 2015. To recharacterize means to unwind the
conversion so that the balance in the Roth conversion account is transferred
back to a traditional IRA by means of a direct trustee-to-trustee
transfer. Recharacterizing eliminates
the taxable income from the conversion.
For example, if you originally converted $100,000 to a Roth IRA, but the
investments have declined to $70,000; you would pay tax on $30,000 too much
income and should consider recharacterizing to avoid paying unnecessary taxes.
You are eligible to make a recharacterization by October 15,
2015 if either: 1) you filed your 2014
income tax return on time by the April 15, 2015 due date, or 2) you timely
filed an extension to file your 2014 tax return. An amended tax return is necessary if you
have already filed your tax return. It
appears that if you did not obtain an extension, and you filed your tax return
late after April 15, 2015, that the automatic extension of time to October 15,
2015 to recharacterize is not available.
Once the amount has been recharacterized back to the
traditional IRA, you may “reconvert” once more to a Roth IRA. However, the reconversion cannot be done
before the later of: 1) 30 days from the
date of recharacterization or 2) the beginning of the tax year following the
year of the initial conversion. For
example, if you originally converted your traditional IRA to a Roth IRA on
December 15, 2014, and you recharacterized the conversion on October 15, 2015,
then you may not reconvert until November 14, 2015. On the other hand, if you converted on
January 8, 2015 and recharacterized on November 17, 2015, you may not reconvert
until January 1, 2015. Reconversion
gives you an opportunity to convert the recharacterized IRA funds back to a
Roth IRA at a lower tax cost, assuming that the account value doesn’t increase
during the waiting period and assuming no change in the effective income tax
rate from the tax year of the original conversion.
