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So, you converted a traditional IRA to a Roth IRA last year, paid
tax on the converted amount, and your Roth tanked. Help may be available—if
you hurry. If you meet the time deadlines, you can "unconvert” or
recharacterize all or part of the Roth IRA conversion you made during the
last calendar year. The recharacterization will return you to a tax
position as if you had never made the Roth IRA conversion. You will
have a lower balance in your IRA (remember your investment tanked…), but
at least you will not have to pay the taxes on the conversion or you will get a refund if the taxes were already paid.
If it is now before April 15 of the year after your conversion and you have not yet filed your tax return, you may make the proper "election and transfer" (see below) to recharacterize your conversion before you file your tax return. The same is true if it is before October 15 of the year after the conversion, and you have not yet filed your return but you have properly obtained an extension (using IRS Form 4868) to file your return through October 15.
If you filed your tax return by the normal due date (usually April 15th), you have until October 15 of the year after conversion to properly undo it with a qualified recharacterization even if you did not file for an extension with Form 4868. If this is the case, you will need to make the election and transfer to recharacterize it by October 15 and file an amended tax return by the normal due date for amended returns (normally 3 years after the original return was filed). The amended return is filed on Form 1040X with the words “Filed Pursuant to Section 301.9100-2” written along the top margin of Form 1040X (IRS forms are available from the IRS website, http://www.irs.gov/).
If it is before October 15 of the year after the conversion, and you have properly obtained an extension, but you have already filed your tax return you also have until October 15 to properly undo it with a qualified election and transfer. In this case, you do not have to use the words “Filed Pursuant to Section 301.9100-2” on the top margin of Form 1040X. In either case, when filing the amended return, attach a statement explaining the details of what has occurred including the amounts converted, recharacterized, earnings thereon, and changes to income.
Whether filing the amended return is
worth the aggravation and expense depends on the amount of the
conversion and the amount the investment dropped. I would probably want
to see at least a $1,000 drop before the amended return becomes
worthwhile.
If an accountant or CPA prepares your tax
return, review with them whether it pays to recharacterize. To give you
some type of price guideline, our CPA firm would charge about $125 to
prepare an amended return if we had prepared the original return. It
would be closer to $200 or more if we had not prepared the
original return.
How to Make the Recharacterization "Election"
Before you file your original or amended return, you
must notify the Trustees (the financial institutions holding your
IRA―for both the IRA and the Roth IRA) on or before the transfer date
that you want to “unconvert” or recharacterize a particular Roth IRA. The notification must contain the following information:
- the type and amount
of the contribution to the Roth IRA to be recharacterized;
- the date on which
the contribution was made and the tax year for which it was made;
- a direction to the
Trustee to transfer, in a trustee-to-trustee transfer, the amount of
the contribution and any net income allocable to it to the Trustee of
the recipient IRA;
- and any additional
information needed to make the transfer.
If both of your IRAs are maintained by
the same Trustee, simply redesignating the IRA will be treated as a
trustee-to-trustee transfer.
You must also notify the IRS of the election by attaching Form 8606, Nondeductible IRAs, to the return. Also, attach a statement to the return explaining the recharacterization.
_____________________________________________________
An aggressive conversion strategy using recharacterizations was the subject of a
peer-reviewed article designated
as Editor's Choice in the September-October 2002 issue of the
Journal of Retirement Planning, published by CCH Incorporated.
[i]
Reg. Section 1.408A Q&A-6(a).
[ii]
Reg,. Section 1.408A Q&A-1(a).
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James Lange, JD, CPA, is a nationally recognized tax and retirement and estate planning attorney with a thriving practice in Pittsburgh, Pennsylvania He is also the author of the bestselling book Retire Secure! Pay Taxes Later: The Key to Making Your Money Last as Long as You Do. He offers well researched, time tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, will and trust preparation, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in the Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Report and The Tax Adviser.
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