Can You Reverse/Undo a Roth IRA Conversion?

If you make a Roth conversion early in a calendar year and then for some reason discover that your AGI will exceed the $100,000 threshold, then the tax law allows you "re-characterize" your Roth and have the money rolled-back into your regular IRA without a penalty.

How many times in your life do you wish you had a “do over” or “take back“.

Often times your stuck with the decision you made and the repercussions that come along with it.

When it comes to investing, many of us have made mistakes over the years. Whether is was underfunding your retirement plan or buying that “hot stock tip” that turned into a disaster; these are decisions that are irreversible.

One decision that does allow you to cash in a “redo” is the Roth IRA conversion.

For those that may have converted their Roth IRA prematurely, here’s what you need to know to reverse it back to a traditional IRA better known as a “Recharacterization“.

Here are the rules on the IRA Recharacterization that you need to know.
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IRA Recharacterization

IRA Recharacterization Rules

IRA Recharacterization Rules

As the stock market continues its roller coaster of 2009, many are seeking for positive news.  While I’m sure that there are many good buys out there, one thing that is certain are that we can look to benefit from tax savings.  How, you ask? Well, in down times, one thing that investors can look forward to is to take advantage of things such as tax loss harvesting in taxable investment accounts, which involves selling depreciated holdings to take advantage of losses that can offset other income.  Not only in taxable accounts, but we may also be able to take advantage of retirement accounts as well. This is what’s called IRA Recharacterization.  Some of the issues can be complex; but with a little bit of information, we can try to make sense and explain the rules.

The Roth IRA Conversion

As you may or may not know, Roth and traditional IRAs are retirement vehicles that allow you to shelter income from taxes.  In a Roth IRA, withdrawals can be tax-free and as an investor, you are not required to take distributions at the age of 70 ½ as you would with a traditional IRA.  The trade-off, of course, is that with the Roth IRA there is no tax deduction like you would get with a traditional IRA or a 401(k).

In a market as such, some investors may have done what’s called a conversion where they have converted their traditional IRA to a Roth IRA.  This could be advantageous for some that are looking to take advantage of the tax-free withdrawals in the Roth IRA.  The one drawback by converting is that when you do convert from a Roth IRA to a traditional IRA, the entire amount is treated as ordinary income, which means we will have to claim that amount on your income taxes for the year and pay the appropriate income tax.  For those that had converted for 2007, the value that was converted then, if invested in the stock market, most likely is worth less now.  As an example, if you had $20,000 in your traditional IRA that you converted last year that value may be worth only $15,000 today. [Read more…]