Author: Nick Prigitano
A common retirement planning tax strategy is to convert money from an IRA account to a Roth IRA. In doing so you pay taxes on the amount converted now, and in return, get tax-free principal and earnings in the Roth in the future. Sometimes this conversion doesn't turn out the way you expected when you did the conversion. The IRS allows you to generally reverse course by October 15th of the following year. Therefore, if you've made a conversion and are looking to correct it, time is running out for a conversion done in 2017.
Why would I want to reverse a conversion?The technical term for undoing a conversion is a recharacterization. This allows you to redo a conversion and put the money back in the IRA where it came from. Why might someone want to do that? There are a couple of reasons why.
One might be that you found that doing the conversion last year put you in a higher tax bracket than you were expecting. You are taxed on the converted amount, and if you converted too much it can cause you to owe more taxes than you expected or lose deductions/credits. A recharacterization would allow you to undo some, or all, of the converted amount to reduce your tax liability.
Another reason that you might undo a conversion is if the asset transferred has decreased in value. An example of this is if you converted $10,000 of a mutual fund in 2017 and it is now worth $7,500. You would be taxed on $10,000, but now the investment is worth less. This means you would be taxed on more income than investment is currently worth. A recharacterization would allow you to put that investment back and forget that it ever happened.
How long do I have to do a recharacterization?For a conversion made in 2017 you would have until October 15th of 2018 to do the recharacterization if you filed your taxes by April of 2018. However according to IRS1 , conversions done after 12/31/2017 may no longer be undone (recharacterized). This is your last chance to correct a conversion gone awry by amending your return and is something to review to potentially save some money on your 2017 taxes.
Can I still do conversions in 2018?You are still allowed to convert funds from your IRA to your Roth and pay taxes now as you have in the past. However, there are no more mulligans the following year. What's done is done, and there is no do-over if the investment depreciates or it you put yourself in a tax bracket/situation that you didn't account for. Without the extra flexibility it is more important than ever to evaluate carefully before making the move.