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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.