Reconverting? 4 Things You Need to Know
By Sarah Brenner, IRA Analyst
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You converted your traditional IRA to a Roth IRA. Then, you recharacterized those Roth IRA funds back to a traditional IRA. You are not alone. Many taxpayers recharacterize Roth IRA conversions. This is especially common in times of market volatility. For many taxpayers, a recharacterization makes sense when faced with a Roth IRA that declined in value since the conversion. Why pay a tax bill on value that no longer exists? After the recharacterizion, you may be wondering… what next? Should you give a Roth IRA conversion a second try? Is a reconversion right for you? Here are some things you need to know.
- A Waiting Period Applies for Previously Converted Funds
The rules say that if you convert and then recharacterize, you cannot reconvert those same funds until the year after the year of the conversion or more than 30 days from the recharacterization, whichever is later. This rule can be complicated!
For example, twins Mike and Ike, both converted their respective traditional IRAs to Roth IRAs on January 10, 2015. Mike recharacterized his Roth IRA back to a traditional IRA on October 1, 2015. As of January 1, 2016 (the year after the year of the conversion), Mike could reconvert those funds to a Roth IRA. His brother, Ike, recharacterized his Roth IRA back to a traditional IRA on February 29, 2016. Ike will not be eligible to reconvert until March 31, 2016 (more than 30 days from the recharacterization).
If the twin’s younger sister, Candy, converted her traditional IRA to a Roth IRA on January 3, 2016 and decided to recharacterize that conversion back to a traditional IRA on February 29, 2016 (the same day Ike recharacterized his 2015 Roth IRA conversion) she would not be eligible to reconvert until January 1, 2017. This is because Candy converted in 2016, not in 2015 like Ike, so the later of the two dates for her would be the year following the conversion, not more than 30 days from the recharacterization, as it was for Ike.
- No Waiting Period for New Traditional IRA Funds
New traditional IRA funds can be converted at any time. For example, if Candy from the example above had another traditional IRA, which she had never converted, she could convert those funds in 2016. The fact that she had converted and recharacterized other traditional IRA funds makes no difference. She would only be required to wait until January 1, 2017 to reconvert those funds that had previously been converted in 2016.
- Reconversion Tax Benefits
Reconversion can bring tax benefits. If the funds have lost value since the original conversion, the tax due on the reconversion will be calculated on the new lower amount at the time of the reconversion. Your Roth IRA will have the same assets that were in the account prior to the reconversion but with a smaller tax bill (assuming no significant gains/losses in between the recharacterization and reconversion).
- Reliable Advice Needed
The rules for eligibility to reconvert can be complicated. Is it worth it for you? The answer for many taxpayers will be yes. To be sure that reconversion is the right move for you, you will want to consult with a knowledgeable advisor. An advisor who knows the rules can help you determine if a reconversion would benefit you from both a tax and financial planning standpoint and also oversee the transaction to be sure that it gets done in a timely and correct manner.