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Roth conversions have been popular over the last year or so. You may have even done a Roth conversion yourself. Did you know you can “undo” a Roth conversion? You can, in a process called a Roth “recharacterization”. This article will cover how to do it. (Note: this only applies to IRAs. If you did a Roth conversion within a 401(k) plan, you cannot reverse it.)
Background — What is a Roth conversion?
There are two types of Individual Retirement Arrangements (IRAs): traditional and Roth.
When you put money into a traditional IRA, you can take a tax deduction (if your income is within certain limits). Earnings grow tax-free. You are taxed when you withdraw money from the IRA.
Roth IRAs work differently. Money you put into a Roth IRA is not tax deductible, but withdrawals from a Roth account are tax-free if you are over age 59 1/2 and have had the account for at least 5 years.
It is possible to convert a traditional IRA into a Roth IRA. The process is rather simple. You simply move the traditional money into a Roth account. On your tax return, you claim the value of the traditional money on the date of conversion as taxable income.
In 2011, you convert your traditional IRA to a Roth IRA when your account balance is $50,000. You will claim $50,000 as income on your 2011 tax return.
How Can You Undo a Roth Conversion?
Here are two reasons why you might want to undo the conversion:
- The account value drops significantly after the conversion.
- You find that you can’t afford to pay the taxes on the conversion.
- Timing. You have until the extended due date of the tax return for the year the conversion initially took place. So if you did a conversion in 2011, you have until October 15, 2012, to do a recharacterization.
- The recharacterization must be done as a trustee-to-trustee transfer. Meaning, it has to be a direct transfer from the Roth IRA to the traditional IRA. You can’t have a check written to you which you then deposit into the new IRA.
“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”