Conversion Nightmares

Wednesday, May 20, 2020

By Sarah Brenner, JD
IRA Analyst
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With markets down, many IRA owners are thinking this may be the time for a Roth IRA conversion. Converting when account values are down can be a good bargain. You pay a tax bill on a lower balance now in exchange for potential tax-free growth down the road when the markets bounce back.

This can be a great strategy, but you need to be careful in executing your conversion transaction. We have heard more than one horror story of IRA owners who have gotten into trouble trying to convert IRA funds online on a custodians’ website, sometimes accidentally pressing a wrong button or putting a decimal point in the wrong place. As result, these unfortunate IRA owners have ended up with a “conversion nightmare” sometimes mistakenly converting thousand more than what they wanted. (And in one conversion nightmare, millions more!)

The problem is that there are no “do-overs” for unwanted conversions. To raise revenue for other tax breaks, Congress eliminated the ability to recharacterize unwanted conversions in 2018 with the Tax Cuts and Jobs Act. Now there is no way in the existing IRA rules to undo an unwanted conversion, even one that was done purely by accident.

There are no good solutions here. An IRA owner may try to ask the custodian for mercy and help undoing the transaction, but there is no guarantee that the custodian will cooperate. Custodians may be hesitant to undo a transaction that Congress said clearly should not be undone. Perhaps a tax professional might be able to plead the case to the IRS to try to get some relief, but this would be expensive, time consuming, and a successful outcome is far from guaranteed.

The best bet, since many financial organization’s websites can be confusing and mistakes are not cheap, is to get professional advice when embarking on a Roth IRA conversion. Good advice from a knowledgeable tax or financial advisor is critical in the decision as to whether a conversion is the right move. It is also essential to be sure the transaction is done properly to avoid “conversion nightmares.”

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