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Roth Conversions: Part V Recharacterizations

This is my final post on Roth Conversions – I think. After careful consideration – understanding the differences between a Traditional and Roth IRA and determining that it is likely the best decision for you, you converted your Traditional IRA to a Roth! Feeling so good about the decision, you attempt to educate all your friends about the virtues of such a decision. There is a little extra skip in your step as you have figured out a way to “Beat the man” and make up some lost financial ground. Then it happens… Maybe you receive a pink slip on Friday (Or email), maybe Susie announces that she is moving back in (With her family!) since she and hubby are out of work… a sink-hole just appears. Something happens that you did not consider and it really does not fit very well into the Master Plan.

The  Master Plan provided for the tax liability generated by your Roth Conversion.  Now, those tax dollars must be used to make Susie and hubby’s house payment. If the tax due on conversion were $50,000 or $500,000, it makes no difference – it could be a million. There is just no longer any available cash to pay those taxes. What can you do?

As unlikely as it might seem, there is good news! By meeting certain requirements, you can Recharacterize the Conversion – what? To recharacterize is nothing more than recinding or undoing the conversion.

 When an individual recharacterizes a Roth conversion, in effect, it is as though the conversion never occurred, and the funds are treated as having never left the traditional IRA.

There is one very important thing to keep in mind. The deadline for recharacterization of your Roth IRA funds (i.e., for transferring the funds) is October 15 following the year of conversion. Also, if you convert funds to a Roth IRA and then switch the funds back to a traditional IRA through a recharacterization, you’ll have to wait before you can reconvert those funds to a Roth IRA. You can’t convert and reconvert an amount during the same taxable year, or if later, during the 30-day period following a recharacterization. If you reconvert during either of these periods, the conversion will be a failed one.

Once again I recommend that you seek competent professional help with these somewhat complicated decisions. For you Do-It-Yourselfers, IRS has its own 110 page publication on IRAs.

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