Wednesday, July 21, 2010

Don't Recharacterize Too Soon

Some taxpayers who did Roth conversions earlier this year have seen their account values drop. As a result, they are considering doing a recharacterization of their Roth back to an IRA. But maybe they should wait a while. Why? Maybe, if they wait long enough, the Roth account will recover and not need to be recharacterized.

The better answer, however, lies in the rules for reconverting assets once they have been recharacterized. A 2010 Roth conversion that is recharacterized in 2010 cannot be reconverted until at least 2011. What if you converted in January 2010, your assets decline, so you recharacterize in August 2010? Now you cannot reconvert those funds to a Roth IRA until January 1, 2011. If the account recovers, you will have to pay income tax on the increased value when you reconvert. A 2010 conversion that is recharacterized in 2011 can be reconverted after a 30-day waiting period. In no case can you reconvert in less than 30 days.

The biggest issue, however, may be the ability to spread the taxes over 2 years, 2011 and 2012. That option is only available for a 2010 conversion. If you recharacterize a 2010 conversion in 2010 you lose that option - even on your reconversion. The reconversion will be done in 2011 and you cannot split the income on a 2011 conversion.

Everyone who timely files their tax return and pays their taxes has until October 15th of the year after the conversion to do a recharacterization. For conversions done in 2010, you have until October 17, 2011 to recharacterize. You don’t have to do it now. Take your time and evaluate all your options before making the recharacterization decision.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler
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