50 Ways to Leave Your Roth IRA

By Dianna Doreen
Writer, mPower

In this article Revisiting the Roth switch Some investors regret moving to a Roth Deadline to reconvert your Roth A case study Roth's loss Staying with Roth Points to remember Glossary of terms

It used to be that you could convert your IRA from traditional to Roth and back again as many times as you wanted to in a calendar year. But things have changed.

As of January 1st, 2000, a reconverted IRA can't go back to a Roth in the same tax year, or until 30 days after the reconversion, whichever is later. If you recently converted from a traditional to a Roth IRA or opened a Roth IRA and are having second thoughts, this article is for you.

Named for Senator William V. Roth, Jr. (R-Del.) and introduced in January 1998 as a new kind of retirement vehicle, the Roth IRA is considered a "tax-free" alternative to a traditional IRA. Roth contributions aren't tax deductible, but accumulated gains withdrawn upon retirement are tax-free, if you meet the conditions.

There are a few reasons why investors might regret having switched to a Roth IRA.

1. Investors can guess that at retirement age their tax rate will be either lower or higher than their current rate, but what's harder to predict is stock market performance. Paying tax on an amount that's no longer in an account is a bitter pill to swallow.

Barry C. Picker, a certified public accountant in Brooklyn, N.Y., was quoted in Business & Your Money Personal Finance as saying, "If you are down 10% or greater on your IRA since you converted (from traditional to Roth), you should definitely do this (reconvert)."

2. If you do an "excess reconversion" the IRS won't allow it. In other words, you may convert a traditional IRA to a Roth, then recharacterize it back to a traditional IRA all in the same tax year. But if you try to reconvert it to a Roth again in the same tax year, the IRS won't allow it.

3. If your income is above the limit for conversion to a Roth, which is currently $100,000 for married or single filers, you'll have to reconvert back to a traditional IRA.

4. You may want to reconvert if the income from your Roth conversion puts you in a higher tax bracket that disqualifies certain tax breaks.

5. If you think you'll need the money soon, it makes sense to reconvert. As a Roth IRA investor with a short time frame, you'll have less time to recoup the money lost from the taxes paid out due to your Roth conversion.

The law allows you to reconvert from Roth back to a traditional IRA, without tax or penalty. The deadline is December 31 of the year in which you did the conversion.

Take the case of Anita, a 38-year-old senior technical designer and skilled seamstress. (She preferred not to have her real name published; Anita is a pseudonym.)

Anita converted her traditional IRA to a Roth IRA in 1999 for the long-term tax advantages. During that summer, however, she got the opportunity to travel to Greece and sew costumes for a summer production Shakespeare festival. The thought of a tax bill hanging over her head once she returned from Greece made Anita rethink the Roth IRA, and ultimately decide to reconvert.

Here's what she did. First, Anita set up a traditional IRA with the same trustee as for her Roth. Then she instructed the trustee to make a trustee-to-trustee transfer of the conversion amount, plus earnings since the conversion, to the new traditional IRA. She notified the trustee that she was electing to recharacterize the conversion amount, essentially treating it as if it had been originally contributed to the new, traditional IRA. This meant Anita had no taxable income to report from the prior Roth conversion.

A converted-to-Roth investor's tax liability is based on the value of his or her IRA at the time of conversion. The new Roth investor pays tax on that amount, even if the account is worth less when the tax is actually paid.

Upon reconversion, the value of the account is transferred, plus any earnings, back to a traditional IRA. In this way, the investor's tax bill is once again deferred until retirement.

Here's what the scenario might look like if an investor reconverts due to a Roth loss:

$2,000 Traditional IRA Conversion to Roth After some market volatility … Roth IRA now worth $1,500 Reconversion to Traditional $1,500 Traditional IRA = taxes paid at retirement on the $1,500 investment's gains

Investors often have a hard time paying taxes on money they don't have. If you convert your traditional IRA to a Roth, and it declines in value during the year, you can return to a traditional IRA and the bandage of a deferred tax bill.

If you plan to leave your IRA to your heirs, there may be advantages to staying in a Roth IRA. This is a complicated area, and you should consult your tax advisor.

If you suspect your income tax rate will be higher during retirement than it is now, the benefit of having gains that are not taxed at retirement could be considerable. Nontaxable retirement income is one attribute that can make a Roth IRA a desirable investment.

For specific recharacterization filing steps, you can visit Kiplinger TaxCut Federal Updates & Workarounds "Erroneous Roth IRA Conversion"

• Starting January 1st, 2000, a reconverted IRA can't go back to a Roth in the same tax year or until 30 days after the recharacterization, whichever is later.

• Consult the issuer or trustee of your Roth for details on how to recharacterize your Roth conversion.

• Don't go conversion crazy. You might fall into the "excess conversion" trap. For information specific to your tax situation, including Roth reconversion, you can call the IRS 24-hour hotline, at 1-800-829-1040.

However, any reconversions done before November 1, 1999 will not be counted when the IRS determines whether any later reconversion was considered excessive.

Glossary of terms

Traditional IRA - Retirement savings account funded by contributions that may be tax-deductible, depending on circumstances. Gains are taxed upon withdrawal.

Roth IRA - Retirement savings account funded by contributions that are never tax-deductible. Gains may be withdrawn tax-free, if conditions are met.

Conversion - Transfer of funds from a traditional to a Roth IRA.

Reconversion - Transfer of converted funds from a Roth IRA to a traditional IRA

Recharacterization - Transfer of funds from one IRA to another, but often used to describe the transfer of reconverted funds.

Excess Reconversion - A recharacterized amount that has been once again converted and determined by the IRS to be "excessive."

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

50 Ways to Leave Your Roth IRA

By Dianna Doreen
Writer, mPower

In this article Revisiting the Roth switch Some investors regret moving to a Roth Deadline to reconvert your Roth A case study Roth's loss Staying with Roth Points to remember Glossary of terms

It used to be that you could convert your IRA from traditional to Roth and back again as many times as you wanted to in a calendar year. But things have changed.

As of January 1st, 2000, a reconverted IRA can't go back to a Roth in the same tax year, or until 30 days after the reconversion, whichever is later. If you recently converted from a traditional to a Roth IRA or opened a Roth IRA and are having second thoughts, this article is for you.

Named for Senator William V. Roth, Jr. (R-Del.) and introduced in January 1998 as a new kind of retirement vehicle, the Roth IRA is considered a "tax-free" alternative to a traditional IRA. Roth contributions aren't tax deductible, but accumulated gains withdrawn upon retirement are tax-free, if you meet the conditions.

There are a few reasons why investors might regret having switched to a Roth IRA.

1. Investors can guess that at retirement age their tax rate will be either lower or higher than their current rate, but what's harder to predict is stock market performance. Paying tax on an amount that's no longer in an account is a bitter pill to swallow.

Barry C. Picker, a certified public accountant in Brooklyn, N.Y., was quoted in Business & Your Money Personal Finance as saying, "If you are down 10% or greater on your IRA since you converted (from traditional to Roth), you should definitely do this (reconvert)."

2. If you do an "excess reconversion" the IRS won't allow it. In other words, you may convert a traditional IRA to a Roth, then recharacterize it back to a traditional IRA all in the same tax year. But if you try to reconvert it to a Roth again in the same tax year, the IRS won't allow it.

3. If your income is above the limit for conversion to a Roth, which is currently $100,000 for married or single filers, you'll have to reconvert back to a traditional IRA.

4. You may want to reconvert if the income from your Roth conversion puts you in a higher tax bracket that disqualifies certain tax breaks.

5. If you think you'll need the money soon, it makes sense to reconvert. As a Roth IRA investor with a short time frame, you'll have less time to recoup the money lost from the taxes paid out due to your Roth conversion.

The law allows you to reconvert from Roth back to a traditional IRA, without tax or penalty. The deadline is December 31 of the year in which you did the conversion.

Take the case of Anita, a 38-year-old senior technical designer and skilled seamstress. (She preferred not to have her real name published; Anita is a pseudonym.)

Anita converted her traditional IRA to a Roth IRA in 1999 for the long-term tax advantages. During that summer, however, she got the opportunity to travel to Greece and sew costumes for a summer production Shakespeare festival. The thought of a tax bill hanging over her head once she returned from Greece made Anita rethink the Roth IRA, and ultimately decide to reconvert.

Here's what she did. First, Anita set up a traditional IRA with the same trustee as for her Roth. Then she instructed the trustee to make a trustee-to-trustee transfer of the conversion amount, plus earnings since the conversion, to the new traditional IRA. She notified the trustee that she was electing to recharacterize the conversion amount, essentially treating it as if it had been originally contributed to the new, traditional IRA. This meant Anita had no taxable income to report from the prior Roth conversion.

A converted-to-Roth investor's tax liability is based on the value of his or her IRA at the time of conversion. The new Roth investor pays tax on that amount, even if the account is worth less when the tax is actually paid.

Upon reconversion, the value of the account is transferred, plus any earnings, back to a traditional IRA. In this way, the investor's tax bill is once again deferred until retirement.

Here's what the scenario might look like if an investor reconverts due to a Roth loss:

$2,000 Traditional IRA Conversion to Roth After some market volatility … Roth IRA now worth $1,500 Reconversion to Traditional $1,500 Traditional IRA = taxes paid at retirement on the $1,500 investment's gains

Investors often have a hard time paying taxes on money they don't have. If you convert your traditional IRA to a Roth, and it declines in value during the year, you can return to a traditional IRA and the bandage of a deferred tax bill.

If you plan to leave your IRA to your heirs, there may be advantages to staying in a Roth IRA. This is a complicated area, and you should consult your tax advisor.

If you suspect your income tax rate will be higher during retirement than it is now, the benefit of having gains that are not taxed at retirement could be considerable. Nontaxable retirement income is one attribute that can make a Roth IRA a desirable investment.

For specific recharacterization filing steps, you can visit Kiplinger TaxCut Federal Updates & Workarounds "Erroneous Roth IRA Conversion"

• Starting January 1st, 2000, a reconverted IRA can't go back to a Roth in the same tax year or until 30 days after the recharacterization, whichever is later.

• Consult the issuer or trustee of your Roth for details on how to recharacterize your Roth conversion.

• Don't go conversion crazy. You might fall into the "excess conversion" trap. For information specific to your tax situation, including Roth reconversion, you can call the IRS 24-hour hotline, at 1-800-829-1040.

However, any reconversions done before November 1, 1999 will not be counted when the IRS determines whether any later reconversion was considered excessive.

Glossary of terms

Traditional IRA - Retirement savings account funded by contributions that may be tax-deductible, depending on circumstances. Gains are taxed upon withdrawal.

Roth IRA - Retirement savings account funded by contributions that are never tax-deductible. Gains may be withdrawn tax-free, if conditions are met.

Conversion - Transfer of funds from a traditional to a Roth IRA.

Reconversion - Transfer of converted funds from a Roth IRA to a traditional IRA

Recharacterization - Transfer of funds from one IRA to another, but often used to describe the transfer of reconverted funds.

Excess Reconversion - A recharacterized amount that has been once again converted and determined by the IRS to be "excessive."

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.