“Drizzle, Drazzle, Drozzle, Drome – time for zis one to come home…”
So you’ve done a Roth Conversion and now you’re ready to do your taxes and (horrors!) you see the bill for the conversion! Yikes! Somehow a simple decimal point miscalculation has caused your nice little conversion to run up a HUGE tax bill… What to do?
Well, just the same as with Tooter the Turtle in the old cartoon, you can follow Mr. Wizard’s advice and “be just what youse is, not what youse is not” – in other words, you can undo the conversion, so that you are back where you started. This is called a Recharacterization of the IRA.
The Great Undo
When you get yourself into such a situation, a complete “undo” is the cleanest way to go about this. So what you do is simply move the holdings back into the IRA account from the Roth, and file a form 8606 with your tax return. The recharacterization must be complete by the deadline for filing your return, plus extensions, which means by October 15 of the following year for most folks.
On the form 8606, you’ll indicate the amount that was converted to the Roth IRA, then indicate how much was recharacterized, and show the gain or loss on the funds, as well. This is one reason why it makes very good sense to open a new Roth account for each year’s conversion. Once the deadline for recharacterization has passed, you can roll over the converted funds into your regular Roth account to reduce paperwork (but of course, you don’t have to do this).
One additional reason besides the tax bill that many folks decide to recharacterize their Roth conversion is because the value of their holdings in the account has decreased, and they don’t want to pay tax on the higher value. For example, if you converted $10,000 to a Roth account and the market took a 40% dive (like that’s never happened, right?) – when it comes time to pay taxes, you’d owe (for example) 25% on the originally-converted $10,000, while your account is only worth $6,000 now. For lots of folks, that’s just too much to stomach, so they recharacterize. After 30 days, they can then convert the funds again at the new, lower value, and forestall the tax until the following tax year (since presumably this is the following year from the original conversion by now).
Stay tuned for more – it can get pretty complicated… see here for more.
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I can learn from you, you can learn from me - please leave your comments and links!Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 20 years of experience in the industry. . Read more from this author
» A Terrible, Terrible Idea
» Using Capital Gains and Losses to Help With a Roth Conversion
» Roth Conversion While Receiving 72t Payments
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[...] you might want to subscribe to the RSS feed for updates on this topic.Powered by WP Greet BoxIn a recent article, I briefly covered the topic of Recharacterization. The example that I gave was pretty simplistic [...]